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A Crystal Ball on Cannabis

19/10/2018


​​Canada made history, October 17, 2018, with the legalization of recreational adult-use cannabis.  Financial institutions, including credit unions, are continuing to mull over how they will play a role with this nascent industry.

Uncertainty around how the cannabis sector will unfold has gripped industry insiders, investors and the public alike. Here, MNP's Peter Guo, B.C. Leader, Enterprise Risk Services, provides his top five things to look at over the next weeks and months.

Constrained Retail Landscape

Expect either a mellow, non-event on the retail side for the first few weeks, with some media hype of store openings and people in retail stores making their choices for cannabis.

Or it could be complete chaos – starting with the limited number of retail outlets officially able to open. There likely will not be enough to meet consumer demand – estimated at 400,000 (or more) kilograms a year on the black market - at the beginning because of retail application licensing issues and delays.

The ability of various provincial governments to review and approve retail applicants, in addition to some setting up provincially-owned and operated stores will vary across the country.  Moreover, the lead time to set up sales agreements, issue purchase orders, then get products on the shelves is proving to be a challenge; potentially resulting in bottlenecks and shortages. In B.C. – which boasts sales agreements with 32 of the 65 cannabis cultivators across Canada licenced to sell - only one government-run retail outlet opened on the big day, in Kamloops.

But that's okay – in the emergence of any new industry with regulatory oversight, particularly with the various hybrid wholesale and retail systems we have across Canada, there are always kinks.

Supply Chain Learning Curves

To date, Health Canada has approved 120 licensed producers to cultivate cannabis, the bulk (65) in Ontario, followed by B.C. (25) and Alberta (8).  If only slightly more than half of the producers are currently licensed to sell, how many actually have purchase orders with their provincial government(s) – the sole legal source for cannabis distribution?

Many of the licensed producers will have to learn the hard way, as there is definitely  more to the cannabis industry than cultivation. Obtaining licensing through Health Canada, getting their Canada Revenue Agency documentation ready, sourcing the right packaging and getting supply chain and delivery partners in place all are necessary for a successful business.

From a production perspective, are we going to get the full capacity to meet demand on Oct. 17? Most likely, no. In fact, some of the largest licensed producers just announced their sales licenses this week.

Consumers Demand Product Quality​

Other than the initial burst of freedom to consume, several trends likely will emerge and quickly. It will be apparent, after the initial spike and the initial reality of supply shortages, retail consumers will stream into three main groups: those who already use, those who want to try recreational cannabis and adults who are coming back to it.

All three groups, and especially affluent boomers and zoomers, will be very discerning about what kind of cannabis they want, based on the experience and effect they hope to achieve. Therefore, quality of production, composition of cannabinoids and consistent testing are going to be very important, and that will manifest itself very quickly in consumer demands and product choices.

To meet this reality, producers and retailers need to be knowledgeable of strains, compound composition, the concentration of certain cannabinoids and the repeatability of that concentration. Cannabis enterprises will need to test and showcase what their company stands for and having the ability to give consumers confidence of all those factors will be important.  Iterating on consumer demand for consistency, reliability and transparency of products and the effect / experience will be a key competitive driver for licensed producers and ancillary business models.

Consumption and Preference Drive Innovation​

Consumer demand will have several impacts on the recreational cannabis market. The most predictable and agreed on is that until the legal retail market can meet consumer demand, the incentive for an illegal market will continue.

Next, the way adults will start consuming cannabis products will change. Based on retail experience in states like Colorado and California, consumption of flower and bud continues but increased demand for edible products, vapes, infused beverages, etc. will drive product evolution. In fact, consumer interaction with cannabis tilts away from combustion to, frankly, everything else.

Thus, the push for different products will drive the regulatory and licensing regimes around edibles and product controls much faster, in part to thwart the black market expanding, but more important to meet rising consumer awareness, sophistication and demand. With that drive, there will be further improvements in testing, dosing, product composition and labeling in accordance with food and beverage rules—more akin to consumer packaged goods. Currently, a lot of the "grey" market edible products don't have the ability to consistently demonstrate and regulate dose – the psychoactive effect – or the testing to prove it. And that's a problem if one edible product has a mild effect, but the next in the package is much stronger.  Not only is this a health hazard, but we will see consumers turn away from such products.

International Expansion

Becoming the second country in the world, after Uruguay, to make recreational adult-use cannabis legal will play a critical role in promoting Canada's expertise and market share on a global level. Despite growing pains in both regulatory and retail, Canada's knowledge, innovation and experience will set our country up as a leader. More countr​ies will come to look at us for growing techniques, product composition, regulatory framework and taxation schemes, including the U.S. In fact, an early edition of CNN showcased a lively debate on legalizing cannabis, among other drugs in the UK and globally, with Canada held up as the example many should examine and possibly follow.

On an international level, the players that move into the cannabis industry will be different as well. They won't be just medical suppliers; they will be cannabis consumer product companies or life sciences companies, whether growing from cannabis production as a base, or as a global branded consumer or pharmaceutical company that acquires a cannabis producer.

Opportunities and Risks for Credit Unions

While the Health Canada licensing regimes around cannabis cultivation and sales reduces some of the perceived risks involved in banking and lending to this industry, it still requires a large influx of capital as the sector grows.  And as with any business seeking financial services and / or loans, credit unions will have to complete their due diligence. Relying on Health Canada processes in assessing KYC is a good first step when a credit union is considering a potential new business member from the cannabis industry.

Beyond ensuring the enterprise not only has the licensing and regulatory pieces in play or in place, the obvious assessments of a solid business plan and the management team capable to execute it are just as important.

More than ever, ignoring this growing industry is a risk in itself. Like credit unions, many cannabis enterprises will have a local focus in the community, providing employment and other opportunities. Business relationships take a long time to build, but once there, can yield benefits for a long time as successful entrepreneurs prosper and continue to grow.

Peter Guo is the B.C. Leader of MNP's Enterprise Risk Services and B.C. Leader, Cannabis. He can be reached at 604.685.8408 or [email protected]