Case analysis

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timer Asked: Jan 18th, 2021

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  1. Read and review Pot of Gold? The US Legal Marijuana Industry (Case 3) in your text. Conduct a thorough analysis of the competitive landscape of the industry using Porter's Five Forces Model.
    Your analysis should follow APA format including a title page, references page, in-text citations, and use Times New Roman, size 12 font. An appendix section is not required. Your assignment should be at least 3 pages in length, not including title or reference pages.

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Case 3 Pot of Gold? The US Legal Marijuana Industry* By 2018, the legal marijuana industry had established itself as a significant component of both the US agribusiness and medical sectors. Retail sales of legal marijuana in 2017 were estimated at $9 billion by BDS Analytics—most of it for medically‐approved use. The 2017 US marijuana crop was valued (at wholesale prices) at $5.7 billion by Cannabis Benchmarks—as compared to the US wheat crop of $7.4 billion. For the states in which marijuana was legally cultivated and distributed, the benefits included 121,000 direct jobs and $1.2 billion in tax revenues.1 Medium‐term projections for the industry pointed to continued strong growth. ArcView—a marijuana information, consulting, and investment firm—forecast that, by 2021, US consumer spending on legal cannabis would total $20.8 billion, and that the industry would generate 414,000 jobs and more than $4 billion in tax revenue.2 Like most growth industries, the industry has attracted considerable financial interest. Some of the venture capital and private equity funds investing in the industry are listed in Table 1. Investment in the marijuana sector was also facilitated by ArcView Group's intermediating role in linking investors with marijuana entrepreneurs had generated a buzz of excitement about this “new gold rush.” By October 2017, its network of angel investors had invested $125 million in 157 cannabis‐sector companies. TABLE 1Private equity and venture capital funds investing in the marijuana sector Source: https://www.investopedia.com/news/top‐marijuana‐private‐equity‐and‐venture‐ capital‐funds/ Fund Founded Size Notes Privateer Holdings 2010 $129m. Backed by PayPal cofounder Peter Thiel. Investments include Tilray (medical marijuana, The Goodship, (marijuana‐infused candies and cookies), Marley Natural, and Leafly Tuatara Capital 2014 $93m. Investments include Willie's Reserve (owned by Willie Nelson), TeeWinot Life Sciences (cannabis‐based pharmaceuticals), GreenDot Labs (cannabis extracts). MedMen 2016 Opportunity Fund $130m. The investment arm of MedMen Inc., a chain of 11 dispensaries in CA, NY, and NV. Has raised $176m in private equity funding, with an implied valuation of $1 billion. Poseidon Asset Management 2013 $8m. Invests in agricultural technology, SaaS solutions and data analytics for the marijuana industry. Salveo Capital 2017 $2m. Chicago‐based venture capital fund. Initial investments: company Headset (cannabis data analytics) and Front Range Biosciences (biotech) Fund Founded Size Notes Casa Verde 2015 $33m. Investments include Eaze Solutions Inc. (CA‐based medical marijuana home delivery service), Trelis, Green Bits, and FunkSac (marijuana packaging) Phyto Partners 2015 $10m. Investments include: New Frontier (data analytics), firm Grownetics (growing solutions), Leaf (cannabis growing), and Flowhub (business management platform for marijuana businesses). The transformation of the marijuana business from one controlled by criminal gangs to a legitimate business activity supported by an infrastructure of consultants, information providers and investment funds had generated a buzz of excitement about this “new gold rush.” However, there remained perplexing questions over the industry's potential to generate attractive profits. Would the industry offer the sustained high profitability associated with the two other heavily regulated industries supplying recreational drugs—alcohol and tobacco—or would it suffer the squeezed margins and low returns typical of the agricultural sector? Legalization In 1996, California became the first state to legalize the sale of marijuana for medical use. Then, in 2014, Colorado and Washington became the first states to legalize the production, sale, and consumption of marijuana for recreational use. At the beginning of 2018, the sale of marijuana the sale of was legal in 30 states and, for recreational use by adults, in nine states (Colorado, Washington, Oregon, California, Nevada, Massachusetts, Maine, Alaska, and Vermont). Yet, amidst continuing concerns over the physical and psychological dangers of marijuana consumption, the impetus to change federal law was weak. Continuing illegality of the production, sale, and possession of marijuana under federal law was a major handicap for the industry. In particular, firms engaged in producing and selling marijuana had limited access to the US financial system. Banks were fearful that involvement with the industry might contravene drug‐racketeering or money‐laundering rules. In the United States as a whole, law enforcement against consumers and suppliers of marijuana continued to be active. In 2016, there were 653,249 arrests throughout the United States on marijuana‐related charges, down from 693,481 in 2013. Close to 90% of these arrests were for possession. Moreover, the approach to enforcing Federal laws against marijuana had shifted considerably in the transition from the Obama to the Trump administration. In January 2018, US Attorney General Jeff Sessions rescinded the Obama‐era guidelines, known as the “Cole Memo,” which discouraged federal prosecutors from taking action against state‐licensed marijuana businesses. As a result, banks and credit unions became increasingly wary of transactions involving companies engaged in marijuana businesses. The Market for Marijuana The US market for marijuana can be segmented between legal and illegal sectors and between medical and recreational use. Table 2 provides some data. TABLE 2Estimates of the US market for marijuana Market feature Data Numbers of users, 2017 Total users: 33mn. (Gallup poll); 55mn. (Marist poll) Medical marijuana users: 1.7mn. (Marijuana Business Daily). Marijuana sales, 2017 Total legal sales: $9 bn. (BDS Analytics), $5.1–6.1 bn. (Marijuana Business Daily). Medical sales: 60% of total; recreational 40% of total Total illegal sales: $64.7 bn. (ArcView). Leading states for legal marijuana sales, 2017 California $1.45bn.; Washington $7.8bn. Colorado $0.44bn.; Arizona $0.35bn.; Michigan $0.13bn.; Illinois $0.08bn.; Oregon $0.07bn. (Marijuana Business Daily). Number of legal marijuana businesses, 2017 Growers: 2500–3500; Retail dispensaries 3300–4300; Infused product manufacturers: 1600–2000; Testing labs: 100–150 (Marijuana Business Daily) Note: The sources of the estimates are shown in brackets. Marijuana consumption in the United States has been widespread since the mid‐1960s, although estimates of its prevalence are imprecise. According to the National Institute on Drug Abuse: Marijuana is the most commonly used illicit drug (22.2 million people have used it in the past month), according to the 2015 National Survey on Drug Use and Health. Its use is more prevalent among men than women—a gender gap that widened in the years from 2007 to 2014. Marijuana use is widespread among adolescents and young adults… Among the nation's middle and high school students, most measures of marijuana use by 8th, 10th, and 12th graders peaked in the mid‐to‐late 1990s and then began a period of gradual decline through the mid‐2000s before levelling off. Most measures showed some decline again in the past five years… In 2016, 9.4% of 8th graders reported marijuana use in the past year and 5.4% in the past month (current use). Among 10th graders, 23.9% had used marijuana in the past year and 14.0% in the past month. Rates of use among 12th graders were higher still: 35.6% had used marijuana during the year prior to the survey and 22.5% used in the past month; 6.0% said they used marijuana daily or near‐daily.3 Among adults, marijuana consumption was most prevalent among young males between the ages of 18 and 34; however, the fastest growth in marijuana use was among older Americans— especially those over 55.4 Development of Legal Marijuana Industry The two lead states in legalizing recreational marijuana were Colorado and Washington; hence, the industry's development in these two states offers pointers as to how the legal marijuana industry might develop elsewhere—even though the structure and conduct of the industry will depend greatly upon how each state frames its regulations. In the future, California—because of the size of its market and extent of both legal and illegal cultivation—will have the biggest impact on the fortunes of the marijuana industry at the national level. At present, entry into the industry depends critically upon the allocation of licenses. The availability of licenses depends upon the restrictiveness of eligibility criteria and whether the state imposes a limit on the number of licenses. In Colorado, eligibility criteria are strict: licensees must be US citizens, state residents, have clean criminal records, and meet other standards, but there is no quantitative limit on licenses issued. In Washington, a fixed number of licenses are available, and their allocation is by lottery. In California, eligibility criteria are relaxed and there is no quota on the number of licenses that can be issued. As a result, Cannabiz Media predicts that, by the end of 2018, California could grant as many as 10,000 licenses for marijuana businesses.5 However, in all states, receiving a state license is dependent upon local authorization—in Colorado, Washington, and California—many counties and cities have decided against permitting marijuana businesses. As a result, most businesses are concentrated in relatively few locations. In Colorado, over one‐third of the state's 500+ dispensaries are in the Denver metropolitan area. In California, four cities—Oakland, San Jose, Sacramento, and San Francisco—accounted for 30% of all licenses in April 2018.6 In addition to the conditions for obtaining a license, the industry is subject to a vast array of regulatory requirements. All marijuana facilities have to have elaborate security equipment installed, including surveillance cameras and precautions against theft. In addition, every marijuana plant is subject to an elaborate system of tracking that includes RFID tagging. The physical movement of marijuana is also highly regulated—including specifications for the vehicles that can be used to transport marijuana. The issuing of separate licenses for different types of marijuana businesses—growers, distributors/transporters, manufacturers, retailers, and testing labs—tends to reinforce fragmentation along the industry's value chain. Most states encourage small businesses— including social enterprises—in the development of their marijuana industries. However, the evidence in Colorado, Washington, and California shows an increasing role of large enterprises. In Colorado, dispensary chains include Native Roots (21 stores), LivWell (14 stores plus growing and processing operations), The Green Solution (11 stores), Green Dragon (11 stores), and Starbuds (10 stores). In California, multiple license holders include Honeydew Farms LLC (29 licenses), Harborside (12 licenses), KindPeoples (12 licenses), and CA Systematize (8 licenses).7 Vertical integration from seed to retail dispensary is a feature of several of the larger players. The development of the industry has been accompanied by the development of an infrastructure of support services. For example, MJ Freeway offers “seed‐to‐sale” tracking software that meets states' regulatory requirements and assisted operations management; Advanced Cannabis Solutions lease real estate to large commercial growers; Waste Farmers supply soils for cannabis growing; and ArcView Group is a hub for data, investment, media, and consulting. Table 3 shows some of the main features of the legal marijuana industries of Colorado, Washington, and California. TABLE 3Some features of the legal marijuana sector in Colorado, Washington, and California Colorado Washington California Date of legalization Medical 2000 Recreational 2012 Medical 1998 Recreational 2012 Medical 1996 Recreational 2018 Home cultivation Yes (max. 6 plants) No Yes (max. 6 plants) Licensing Separate licenses for cultivation, manufacture and retailing, and for medical and recreational marijuana. State licenses only issued when allowed by local jurisdictions Single licensing system for medical and recreational. Separate licenses for producers, processors, and retailers Separate licenses for cultivation, manufacture, and distribution. License applicants must first have approval from local government. Licensing fees Application fees: dispensary Application: $266 $6000–$14,000; cultivation License fee: 1062 $1000. Licenses: dispensary $3000–$8000; cultivation: $1500–$1800 $1000 application fee. Licenses on sliding scale based on business throughput: e.g., retailers $4000–$72,000; distributors $1200–$125,000. Taxes 2.9% sales tax 15% excise tax plus $9.25 tax per pound on flower and $2.74 per pound on trim (in addition to sales and use taxes) Operational regulation State‐wide tracking system for all plants and processed products Licenses Medical: 503 dispensaries; issued (early 751 cultivators 2018) Recreational: 518 stores 722 cultivators 37% excise tax; 9.6% sales tax 486 retail stores 1147 cultivators. No more licenses being issued 1273 licenses issued: cultivator 322, dispensary/retailer 322, manufacturer 302, distributor 176, microbusiness 57, Delivery 52, testing 15. Notes: aBy 2018, Colorado has highly developed marijuana industry with extensive infrastructure. Marijuana generated over $200m. in taxes and licensing fees for the state. bThe state has had a highly developed illegal marijuana market for decades with substantial production in the east of the state and imports from British Columbia. cTotal production approx.13.5 million pounds per year; consumption approx. 2.5 million pounds— hence massive (illegal) exports to other states. The Economics of the Marijuana Business Cultivation Growing marijuana, whether for the medical or the recreational market, requires, first, a license, and then the acquisition of a growing facility. Marijuana is grown primarily in indoor, climate‐controlled buildings under artificial light, but also in greenhouses and outdoors. Although greenhouse and outdoor cultivation offers economies both in set‐up and operating costs, these advantages are mitigated by the need for extensive security equipment for all marijuana‐growing facilities. More importantly, the key advantage of indoor cultivation is the ability to have multiple growing cycles each year. The average size of an indoor facility is 18,300 square feet; that of a greenhouse is 39,000 square feet.8 The growing process involves the following stages: 1. Establishing stage: cloning new plants from existing female plants and allowing the new plants 7–12 days to become established. 2. “Veg” (or growing) stage: two months under constant light. 3. Flowering stage: about two months with a daily cycle of 12 hours of light followed by 12 hours of darkness. 4. Processing stage: hanging the plants upside‐down, then harvesting their buds and leaves. 5. Curing stage: drying the buds and leaves. Figure 1 shows the layout of a typical growing facility. FIGURE 1 Layout of a typical marijuana indoor cultivation facility Source: J. Maxfield, “More Legalized Drug Dealing: An Inside Look at Colorado's Massive Marijuana Industry,” Motley Fool (January 5, 2014). Early estimates of revenues and costs suggested that marijuana is a highly profitable crop. For example, Motley Fool estimated that a 10,000‐square‐foot growing facility with five annual growing cycles could produce 1250 pounds a year, with a wholesale value of $2.75 million. With production costs of $1.25 million (i.e., $1000/lb.), this implies a margin of 55%.9 However, estimates of production costs are highly variable: one study estimates a range of $70–$400/lb10, while another study puts them as high as $1606/lb.11 As the industry develops and spreads to more and more states, more reliable estimates of revenues and costs have become available. Table 4 provides estimates based on data available during the first half of 2017. TABLE 4Estimates of the costs, revenues and profitability of legal marijuana production, 2017 Source: Marijuana Business Daily, Marijuana Business Factbook 2017. Indoor Greenhouse Start‐up cost (per sq. ft.)a $75 $50 Annual operating cost (per sq. ft.)b $81 $8 Revenue (per sq. ft.)c $151 $26 Average profit margind 30% 40% Percentage of business that is profitable 67% 55% Percentage of business that breaks even 28% 22% Percentage of business that is loss making 30% 44% Notes: aEquipment and real estate accounted for 60% of start‐up costs, licensing, and security for a further 20%. bWages accounted for 30% of operating costs, rent/mortgage for 18%, utilities for 16%. cBecause of quality and consistency, indoor grown marijuana sells at a price premium. dAfter‐tax, net margin. Over time, production costs change. While increased productivity from technological advances and greater operational efficiencies reduce production costs, these are offset by rising real estate costs due to a shortage of suitable facilities and increasing wage rates for marijuana workers— these wage rates tend to be above those for workers in similar horticultural and retail sectors. In Colorado, Oregon, Alaska, and some other states, employees in marijuana businesses are required to have state occupational licenses. Most estimates of the profit margins on marijuana growing have failed to take account of the many risks affect the industry. These include: diseases, natural disasters (California's wild fires of 2017 and 2018 wiped out many producers), and other sources of crop failure. In addition, there is the ever‐present risk of crime that affects all cash‐based businesses and the risk of closure or loss of license resulting from failure to comply with state or local regulations. The greatest uncertainty in projecting future profitability relates to prices. In the wholesale market, prices are determined by supply and demand. Prices vary over times due to spikes in demand (demand peaks during summer and holidays) and seasonal variations in supply (supply from outdoor and greenhouse cultivation increases during the fall). Longer term, there has been an overall downward trend in prices as growth in supply has outpaced growth in demand. Figure 2 shows prices between 2015 and the end of 2017. This downward trend has continued during the first half of 2018. During mid‐August 2018, the average US spot wholesale price was $1130 per pound compared to $1486 at the beginning of the year. These averages masked considerable price variation both between quality grades and localities. During the first half of 2018, wholesale prices in Oregon were approximately 55% higher than those in Colorado.12 FIGURE 2 Average spot wholesale price of marijuana in the US ($ per pound) Source: Cannabis Benchmarks. Retailing There is a huge diversity in the retail outlets supplying marijuana and marijuana processed products. There is a distinction between medical and recreational outlets, with the latter present in only nine states, compared to 30 for medical. Variations in regulations among states mean differences in size, operating practices, costs, and competitive conditions. In addition, some retailers are stand‐alone, other backward‐integrated into cultivation. Some indications of average revenues and costs are shown in Table 5. TABLE 5Average revenues costs, and profitability of licensed marijuana retailers, 2017 Source: Marijuana Business Daily, Marijuana Business Factbook 2017. Medical Recreationala Average outlet size (square feet) 2566 Start‐up cost (per outlet) $0.775m. $0.193m. Annual operating cost (per outlet) $1.920m. $1.140m. Revenue (per outlet) $3.0 ...
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