Why legal cannabis growers can’t compete with the black market — yet

And to successfully compete with a stocked and still-thriving illegal market, the country’s licensed cannabis producers must — among a series of moves — ramp up their crop outputs exponentially, offer cheaper, more varied strains and get them into a vastly increased number of stores.

“This is not a new industry, there is an existing industry,” says Armstrong, who analyzed new Health Canada data on the country’s marijuana market for a recent article. “What we have is this new legal version that has to compete with it.”

But that fresh player — who was only allowed into the game on Oct. 17 of last year — is not coming close to competing yet, Armstrong says.

Its primary problem out the gate was production. Armstrong says the Health Canada data suggests the country’s recreational cannabis market requires some 77,000 kilograms of product a month.

“That’s the existing black market, existing legal recreational buyers — that’s the estimate of the whole thing combined,” he says. “In November, roughly speaking, the legal industry produced about one-eighth of that amount.”

Clearly, legal growers have a long way to go to catch up with the ubiquitous pot farms and grow-ops that exist across the country, Armstrong says. The good news, he says, is that federally licensed production is increasing at a breakneck pace and that adequate legal supplies should be available countrywide by early next year.

Federal figures show the industry grew production by 12 per cent a month — compounded — in the first nine months of last year, Armstrong says.

“If that continues to grow at that compounded rate, which is really a madcap, frantic rate, they’ll actually have enough raw capacity in about a year.”

As greenhouses and converted factories spring up across the country, and even abandoned soccer bubbles are put to new uses, there are questions about whether that exponential production growth can continue, Armstrong says.

One large licensed grower is planning expansions on such whirlwind scales and beyond.

“We’re currently ramping up all of our facilities, both licensed and those in the licensing process,” says Andrew Grieve, CEO of Zenabis, based in Surrey, B.C.

Grieve says Zenabis is adding two facilities — in Langley, B.C., and Nova Scotia — to its two existing plants in New Brunswick and Delta, B.C. With those additional plants, coupled with planned expansions at its existing facilities, Zenabis hopes to catapult its production capacity from just under 10,000 kilograms to 480,000 kilograms annually by 2020.

“As a result we believe there will be producers, ourselves included, who are able to grow high-quality product and actually satisfy the recreational market in Canada,” Grieve says.

Industry expert Nick Pateras says the widespread carping over product shortages since the legal market opened was unwarranted given the predictable production lags that were forced on growers by simple economics.

Pateras, vice-president of strategy at the cannabis resource and information company Lift & Co., says the licensed producers could not have been expected to build enough stockpile or capacity for day one when they had no revenues to cover those costs.

“That’s a pretty big ask to have them grow it … and sit on it for months and months,” he says. “I think (the supply shortage) was always going to happen.

But Pateras says he’s confident production will scale up enormously.

“I think that you are going to see a ton of production capacity come online” in the next two to three financial quarters, he says. “So within a year that supply demand imbalance that we see now will have narrowed greatly.”

Most industry watchers think product shortages will greatly ease over the coming months. Pateras, however, believes that true production needs may have been underestimated, given the high percentage of raw crops that will be demanded by the edible and beverage products hitting the Canadian market next October.

He says offerings like pot-infused gelatins and beer — which together could attract 60 per cent of the market — require far more plants to produce a desired amounts of THC or CBD than combustible products. “It’s a pretty inefficient production process,” Pateras says.

He adds that industry production growth forecasts are often spotty, and notes that many Canadian producers are looking to export some of their wares and that crop loss is often a wildcard factor.

Brock’s Armstrong stresses that these are far from the only challenges the legal industry will face in its push to displace the black market. “The next trick is taking that raw material and getting it into final-product form and out to the retailers,” he says. “That appeared to be one of the bottlenecks in November.”

Armstrong says that with the mass increase in shipping volumes that producers faced in October, many also experienced logistics problems in transporting, testing and warehousing their products. He also says producers and retailers have to put much more work into assessing which products and strains are most popular with consumers and adjust appropriately.

In comparison with the black market, however, price, quality and access — along with increased policing — are going to be key, Armstrong says.

The stick of more and increased legal perils for black-market sellers will surely help the sanctioned industry make headway, he says. Provinces have vowed to boost enforcement of the illegal trade while the federal criminal code sets out harsh sentences, especially for anyone selling to minors.

“I think the main emphasis has to be on the carrot side,” Armstrong says.

Aside from formulating the most desirable and consistent products — something legal producers can do better with laboratory backing — growers and regulators must make cheaper products available to complement high-end wares, he says.

“Governments so far have kind of talked about $10 a gram including taxes, (and) that’s not going to cut it very well against the black market that’s charging $5.50 or $6.50,” Armstrong says.

“It doesn’t have to be all cheaper, but if you can at least have a value brand (so) people can say, ‘I’m not saving any money going to the black market why not go legal?’ ”

Armstrong says the industrial-scale operations legal growers will build will give them and advantage over their furtive, underground counterparts in offering cheaper goods — should regulators allow them to go on sale.

Grieve says his company is intent on offering such cheaper alternatives if allowed.

To compete with underground dealers, many of whom offer customer loyalty discounts and pizza-like delivery times, the legal market must also open far more stores, Armstrong says. While product shortages have limited initial store openings in Ontario to 25, for example, this province needs 1,000 or more stores to be competitive, Armstrong says.

Armstrong says producers must also be freed from the draconian advertising and promotion restrictions Health Canada’s legalizing regulations have imposed.

While regulators have a duty to limit the use of a product with known health and public safety risks, producers need some latitude to compete, Armstrong says.

Current rules limit virtually any advertising and promotion and insist on plain packaging with minimal product information and a tiny producer label.

“But if you really want to get people to switch, you’ve got to explain why, you have to make a sales pitch,” Armstrong says. “And that’s something industry is really going to struggle with.”