In our last issue of CannaQuarterly, we explored several supply challenges and how these market factors are impacting the cannabis industry. Preventing supply chain disruption is essential to protecting revenue. But what can be done to protect price? Declining wholesale prices, like increasing production costs, are often beyond the control of cultivators and retailers, yet heavily influence the price of product. Moreover, setting the optimal price level is a balancing act between short-term liquidity, future cash flow needs, and consumer/market tolerance.
Maintaining consistent gross margins in an environment of declining wholesale and/or retail prices is critical to a company’s long-term viability. This article examines the key trends in play, top considerations, and potential new approaches to markets where wholesale and retail cannabis prices are dramatically changing.
Current conditions impacting pricing
Increased supply during the pandemic
During the early stages of the COVID-19 pandemic, the nation saw an increase in the consumption of cannabis. Consumers opted to spend more on cannabis during this time, and many in the industry estimated that the trend would continue. Regulators in some locations granted additional cultivation licenses and cultivators to increase production to meet the expected rise in demand. This resulted in a surplus of flower and a corresponding drop in price to stimulate consumer activity when demand was more sluggish than anticipated.
The trend of stagnant or declining sales is one being faced by many mature markets. According to MJBizDaily, medical cannabis sales declined in several significant markets during the first half of 2022 compared with the same period last year, such as Colorado (42.8%), Oregon (37.7%), Arizona (16.5%), Massachusetts (10.3%), and Illinois (10.4%).
Despite the shrinking of cannabis consumption, new cannabis operations continue to open in some of these markets at an accelerated rate. Take Michigan, for example, where sales have been up and down over the past few months, per state reporting, and the state’s Cannabis Regulatory Agency “has been hearing concerns that the supply of marijuana produced by licensed growers exceeds, or may soon exceed, consumer demand,” they said in a late August release. “The concerns include that the wholesale price of flower is lower than the cost of production – or will be when harvests are highest in October.” Between July 2021 and July 2022, the average retail price of flower declined 48% in Michigan’s medical market, and 44% in adult-use. During the same time period, average canopy size grew from around 820,000 plants to over 1.8 million, active grower licenses increased 65%, and retail licenses increased 34%.
These circumstances have led to dramatic shifts in pricing dynamics as response to increased supply and competition. In more typical retail situations, operators have some options that are not available to cannabis operators; they might move the product to other locations in other states, as example. Still, there are some ways that cultivators and retailers can protect themselves from price shock.
- Enable data-driven insights to inform business decisions ahead of market shifts. Organizations must harness the power of information to track and respond to changes in the demand-supply balance. Flexible analytics and modeling scenarios allow processors to quickly understand and share demand, performance, labor needs, and revenues. Organizations should look to enable their teams to produce what-if scenarios to tweak forecasts and better understand current and anticipated business performance.
- Build in product differentiation to create new consumer markets. Cultivators experiment constantly with new cultivars, and processors are often found working on innovative formulations. Consider repurposing excess supply into new products with differentiated purpose, then guiding a customer through the experience they should anticipate. This will help consumers with the decision process and ensure that the interaction remains with them well after the purchase. While flower still dominates the landscape, newer consumers are opting for consumer edibles and other non-flower products at a higher percentage, with rapid growth in water-soluble and drinkable infused products.
- Consider creative promotional strategies where regulation permits. Limited-release drops are an opportunity to generate excitement for your product and your business, and to stand out from the crowd. They can be a great chance to promote your business and separate yourself from competitors, as well as send out a test balloon to gauge consumer demand ahead of a product launch.
Uneven distribution of cannabis retail locations
It should come as no secret or surprise that most dispensaries tend to be found in urban centers – after all, “location, location, location” has been preached to retailers for countless years. Higher population density equates to higher likelihood of sales, right? But in markets where licenses are more accessible, this may be a double-edged sword, as operators are far more likely to be competing with peers for the same resources, real estate, and distribution network. If your operation is facing this kind of adversity, consider the following ways to make your location stand out and to create a memorable experience that will keep customers coming back.
Find ways to entice consumers to choose you over your competitors. Do your research, be creative, and have fun with it.
- Create an immersive in-store experience. Compare your customer experience to those of other retailers – even stars outside your market, like Apple, Starbucks, or Lego – to find unique ways to make your store a destination of interest for reasons beyond scoring the latest and greatest cultivar. The persona and consumption patterns of the cannabis consumer vary greatly. Leverage your store locations to dazzle the experienced, educate the less informed, and ultimately win over consumers of all types.
- Train your budtenders to be knowledgeable as well as engaging. Consumers who trust your staff’s knowledge of the product will likely return and make larger purchases. Organizations that tend to nurture the most loyal employees invest highly in worker training; cannabis operators should adopt this practice to develop a cadre of effective sales employees. Find ways to allow workers to convey their knowledge to the clientele. In turn, these employees generate intense customer loyalty and foster customer experiences to differentiate the brand from the competition.
- Consider offering on-site consumption. In states where it is legal to do so, offer on-site consumption as a possible service differentiator. Interacting with guests during the consumption experience allows for immediate product feedback and creates an additional opportunity to educate beyond the sales counter, making cannabis accessible to the uninitiated and creating the potential for new consumer segments.
Pricing vs. the illicit market
It has been a long-held belief that creating legal cannabis markets would combat the illicit market and create price equality and stability; it was expected that consumers would flock to legal sources of cannabis, decreasing reliance on and demand from the illegal alternative. 25-plus years of regulated markets have shown results contrary to this – illicit markets continue to thrive because they are not faced with pricing challenges imposed by taxes or increased production costs associated with quality control and overall compliance. Illicit operations do not adhere to local zoning restrictions, nor do they avoid interstate commerce, and some consumers view access to the illicit market as more convenient than traveling to a dispensary. Decriminalization efforts are further complicating the matter, as both sellers and buyers are less concerned about the legal impact of illicit sales. Particularly in less-populated areas, the lack of access to legal dispensaries drives some consumers to find a more convenient alternative, which often leads them back to the illicit cannabis market.
To mitigate risk of competition from underground markets, find ways to make the user experience compelling and convenient. Consider extending your accessibility as well as your product mix to offer a range of price points and products to serve customers from all segments.
- Identify your current brand identity and the local market dynamics. In which market segments are you currently selling? Are you a value, middle, or premium product? If more than one, how well does each sell through? Do you understand the comparable illicit market in your area and why a consumer might buy there instead of through legal channels?
- Adopt customer-centric thinking. Knowing your target market clientele is important to driving the decisions your company makes regarding the quality of your product. Are those customers willing to pay for premium products? Would they prefer to sacrifice potency or quality for affordability? Is one an untapped market in your area? Let these answers guide the curation of your retail line, and how you craft your brand messaging.
Cannabis’ continued existence as a Schedule I drug creates challenges for every operator – it limits interstate commerce, adds significant constraints to operations, and throttles market performance. The current regulatory environment results in process and product redundancies, as companies need to essentially operate siloed businesses in varying geographies. Cannabis companies operating in multiple territories are expected to maintain state-specific cultivation processes, product formulations, product labels, packaging, and marketing strategies for each product in each market. This causes high operating costs, which ultimately translates into higher selling prices.
Although specific products, packaging, and marketing campaigns may not be able to cross state lines, there are still some bigger-picture strategies that can be applied widely to give those individual efforts a boost in their respective markets. Creative marketing strategies are a great way to curate new and repeat revenue as well as help your management team become more informed on how the customer base might respond to new products and experiences. Just be sure to double-check applicable regulations to make sure you’re fitting within them.
- Now accepting pre-orders! Pre-orders mean guaranteed sales. Maybe you’re releasing a new product category or have bred the next great cultivar. Promote it to get people excited about it! Customers who pre-order are guaranteed to show up to receive their order – which means potential upsells, too.
- Deliver. Delivery is a good way to counteract the convenience that some consumers find in the illicit cannabis market, and it extends the potential range of customers who may not live close to your location. It brings access to consumers who live in less-populated areas at a lower cost than an additional location and fosters brand loyalty over the competition.
Drive performance and plan for the future – in any environment
There are many complexities affecting pricing in the cannabis industry, and successful business owners must anticipate the ever-changing dynamics of evolving regulations, consumer preferences, and disjointed supply chains. These challenges combined with factors like falling wholesale prices heavily influence price well beyond the level of operational control. Adopting strategies to mitigate unstable prices requires organizations to adapt quickly in order to preserve profitability and enable future growth.
Subject matter expertise
Managing Principal – Real Estate, Cannabis Industries
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