There’s a persistent question tickling the back of my brain: How is the legal, regulated cannabis industry supposed to coexist with the illegal, underground cannabis market?
This is a tricky, multifaceted question with socioeconomic, racial justice, rule of law, and business implications. Each of the issues are worth a column on their own, but the business question especially intrigues me, because it all comes down to dollars and cents – something that can be hard to hide when you look at a balance sheet.
Let’s start with some facts.
Studies show that the underground market is taking about 65 to 75 percent of the total market. The total numbers for 2021 legal sales aren’t in yet, but 2021 legal sales have been projected to be around $23 billion. Conservatively, that would put underground market sales at around $61 billion.
Next, operators I’ve talked to say that for the underground market, the wholesale per pound cost of producing cannabis is between $200 and $400 a pound. That’s without testing, seed-to-sale tracking, sprinkler systems, most labor costs, and the fact that underground grows use pesticides and Miracle-gro, significantly boosting yields, while creating a less “clean” product”.
Right now, depending on where you are, wholesale market prices for legal cannabis range from $1,500 a pound in Colorado, to $3,000 a pound in Massachusetts, with everything in between and some places even higher.
Right there is a pretty big gap. Even in Colorado, a “mature” cannabis market, you’ve got wholesale product going for three times more than underground stuff.
Andrew DeAngelo, one of the founders of Oakland, California’s famed Harborside dispensary and a board member of the California Cannabis Industry Association thinks the only way forward is to create a single market, with no regulatory taxes and few requirements. But even after that, he thinks the underground market will always win on price.
“I don’t think the way to get there is for the legal market to match the price. That’s not going to happen because a lot of people trust their dealer more than their dispensaries,” he said. “All you can do is create the best experience. You can create the best product selection you can and try to compete that way. The cannabis trader doesn’t have 25 SKUs of edibles, he might have three. He probably doesn’t have tinctures.”
Erik Williams, COO of CannaProvisions in Massachusetts, but also a former operator of Colorado’s vertically-integrated MiNDFUL, doubles down on DeAngelo’s call for cutting taxes and regulations.
“The only way to compete on price, is for the regulations to drop to a much more reasonable cost. Just the data we have to pay for all of our cameras is massive, just allowing us to test in whatever batch we want,” he said, tallying up the costs. “$480 a test. 15 pounds a test. That’s $32 a pound.”
But still, testing is the brightest dividing line between underground and regulated market products, says Oren Schauble, President of California’s vertically-integrated Unrivaled.
“What you’re smoking is really a matter of health. You’re going to buy things in a black market. They’re just putting things in a package. They don’t have to pass a COA [Certificate of Analysis] test.”
But at least in the Midwest, the veracity of testing has taken a hit lately. A series last month by the Chicago Sun-Times found eight of nine of prerolls they purchased had mold. And a massive November 2021 recall by Michigan regulators is under fire by one the states’ biggest testing firms, charging, among other things, that the regulators don’t have the internal expertise to affirm that a recall was necessary.
“A test result is a lie,” says Rick Thompson, executive director of Michigan NORML. “When someone says it’s tested, it’s a lie. It’s a misleading statement. Just because it passed testing at one point in its life cycle, doesn’t mean it still would pass testing later.”
Ultimately, Thompson says, testing is just a cover for big cannabis companies who are trying to scare consumers away from the underground market.
“Part of the problem for the regulated market is they paid so much for capital and infrastructure and C-suite executives from other industries, they can’t make their stuff competitive,” charges Thompson, who says the underground market will never go away. Regulators and legal cannabis companies should just get used to that idea.
“Coexist. That’s the important phrase here.”
Some states, like Michigan and Maine, have created regulatory regimes that are more porous. For instance, in both states, registered caregivers can grow a significant amount of cannabis for patients, and there are few checks and guidelines on how you do that – or even if you’re limiting your grows to the state mandated amounts. On top of that, in Maine medical dispensaries often buy from caregivers (Michigan ended that practice in 2020), and they aren’t required to either test or use seed-to-sale tracking.
As a result, in 2020, a study found that about 30% of Michigan’s market was operated by caregivers – while the illegal market is at about 35%. That seems like a big step towards bringing the market into the sunlight.
“There needs to be less lip service and more action,” says Canna Provision’s Williams. “If you’re giving social equity applicants the first bite of the apple, it needs to be an apple they can bite. I’d like to see things even smaller. How about the farmer’s market model? Where you grow 200 pounds a year, your regulations should be down for that. Making it easier for people to access the market needs to be the goal.”