Vertical Integration in Cannabis - How Does it Work?

Vertical Integration in Cannabis - How Does it Work?

Published on 11/18/20

Some of the largest companies on the planet got to where they are because they are experts in utilizing vertical integration to their advantage. Across the capitalist world, companies like Apple, Amazon, McDonald's and Zara have established their enviable positions in the global marketplace thanks to a deft understanding and exploitation of the economic strategy of owning and controlling their entire supply chain. Vertical integration is when businesses control the sourcing or supply, manufacturing, distribution, marketing and selling of what they produce. Everything is done "in-house". It is incredibly advantageous to a bunch of big businesses that have managed to position themselves correctly in the market. Efficiency is improved, costs are reduced and the company retains complete control over the entire process of creating a product.

Cannabis & Vertical Integration

It might seem that this type of business structure can only work for massive firms, but it is also present in the world of cannabis. The State of Massachusetts has mandated vertical integration for its medical cannabis businesses since 2012 and only vertically integrated businesses can apply for a medical license from the state. The license allows them to distribute and sell cannabis, but they must also operate their own cannabis grow operations and process the weed completely on their own. The state passed the law to prevent licensed dispensaries from purchasing cheaper marijuana illegally on the black market, but it has primarily only served to  limit the establishment and growth of small cannabis businesses due to their inability to obtain the tremendous amount of capital necessary to open or expand a cannabis operation.

Conversely, when Massachusetts voted to legalize recreational marijuana in 2016, businesses were not required to follow the vertical integration model. The state is now understandably considering doing away with the medical requirements in order to have a more balanced and fair industry. New Mexico finds itself in a similar quandary. Medical cannabis law in the Land of Enchantment requires vertical integration; licensed businesses must produce, manufacture, distribute and dispense medical cannabis products. It's only a matter of time before the state legalizes recreational use, but a recent bill that would do just that failed in some part because of the variety of license types that would available and the extreme difference between how cannabis companies selling recreational weed would be sanctioned as opposed to the existing medical businesses.

Way back in 2010, Colorado implemented what is known as the "70/30 Rule." The law required that medical marijuana retailers grow at least 70% of the product they sell. The idea behind the law was to better enable officials to track cannabis in the state and address concerns that medical marijuana dispensaries were buying weed on the black market. The provision lasted just four years until it was scrapped in 2014 not long after the legalization of recreational use.

Benefits of Vertical Integration

Economy of Scale

An economy of scale allows larger companies to produce more in order to provide customers with lower prices on their products. Processes can be streamlined, efficiency increased and per-unit costs reduced. The larger the business gets, the more cost-effective it is to produce its goods and the less the consumer will have to pay. 

Cost Control

With cost control leverage, companies do not have to set up their pricing to match with outside suppliers and vendors. They run their own supply chain and can control costs more closely, offer lower prices, and, in turn, increase consumer demand and increase their bottom line.

Avoidance of Difficult Suppliers

Suppliers have the power to dictate pricing, terms and availability. A vertically integrated company can reduce costs and avoid being beholden to the whims of outside vendors that can cause external problems like supply disruption. If a business can control its own supply chain, it can handle any supply issues internally and use this independence from suppliers to its benefit.

Eased Communication

A vertically integrated company only has to rely on internal communications to operate. From management down, everything is done in-house and the chance of confusion that can come from outside sources is eliminated. It is easier to establish a cohesive production system when there is only one line of communication.

Drawbacks of Vertical Integration

Significant Amount of Capital is Required

The primary disadvantage of vertical integration is the expense. It is not cheap to own all parts of the supply chain. Owning and operating grow sites, production centers, packaging factories and retail outlets requires access to a great deal of capital.

Loss of Focus

The various levels of a vertically integrated company require a diverse set of skills to manage. It can be difficult for management to keep a keen eye on all aspects of the operation. Addressing issues in one department might lead to neglect in another. 

Variable Technology

Technology is constantly advancing and changing. Various technologies across the different levels of a vertically integrated enterprise can come in conflict and cause hiccups and be expensive to maintain. 

Reduced Flexibility

Companies that are heavily vertically integrated have difficulty responding to trends and changes in the marketplace. It is much more difficult for a vertically integrated company to pivot to address new demands from consumers. They are also less likely to be able to change factories or switch producers in search of cheaper alternatives.

Corporate Culture Issues

Retail and production cultures are very different. One group is driven by marketing and sales and the other is there to manufacture. If management does not maintain a focus on the integrated system as a whole, problems can arise of certain sectors feel that they are not valued as highly or receiving similar support as others. 

Do you work in the cannabis industry? Is your company vertically integrated? What are your thoughts on the advantages and disadvantages of vertical integration in the cannabis industry? Leave a note below.

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