Vertical Integration

Falling wholesale marijuana prices coupled with surging demand for new marijuana-based products, such as extracts and concentrates, should stimulate business owners within the marijuana industry to reevaluate their existing business models. This reevaluation should focus on whether or not their businesses are positioned to take advantage of these trends and whether or not vertical integration could position their companies for more success.

Market Backdrop
The widespread legalization of recreational and medicinal marijuana has led to a massive influx of businesses looking to capitalize on what some have deemed the next American gold rush. As a result, certain segments of the market have become over-saturated with new businesses. One such segment is the marijuana growing sector. The over-saturation of new growing operations has driven down the price of marijuana wholesale prices. For example, in 2016 the average wholesale price in the United States for the first half of the year was $1,938 per pound.i This compares to wholesale prices of $1,340 for the week ending January 12, 2018.ii In certain markets the drop off in prices has been even more stark. In a recent Marijuana Business Daily, one Washington marijuana grower said that he’s struggling to get more than $1 a gram ($454 a pound) wholesale for the cannabis he grows.iii

During this period of explosive industry growth, consumer tastes have also evolved. Specifically, the types of marijuana based products they are purchasing has shifted. One of the fastest growing segments of the marijuana industry is edibles and concentrates. For example, the market share of edibles and concentrates in Oregon increased from 19.6% in 2016 to 33.7% in 2017. This growing demand for edibles and concentrates has come at the expense of the flower. For example, in Colorado, the first half of 2017 marked the first year in which product sales for marijuana flower represented less than half of the market (48.2% down from 54.8% in 2016) whereas concentrates and edibles increased to 41.4% of the market.

This trend hasn’t been isolated to these markets. In the largest US marijuana market of California, demand for concentrates and edibles stands at 37% of the market. Additionally, certain states, like New York, have outlawed the flower in favor of other marijuana based products such as liquids and oils for vaporizing inhalers

Business Models Need to Evolve to Address these Developing Trends
Companies within the marijuana industry need to make sure that their business models are evolving to address the distinct trends outlined above. One possible way of addressing these trends is to consider vertical integration. Vertical integration is the concept of expanding your business by acquiring or developing service offering further downstream or upstream in the industry value chain. For marijuana growers this means adding “downstream operations” and developing additional products such as extracts or concentrates. Whereas marijuana dispensaries would add “upstream operations” by developing their own branded products.

The move towards vertical integration offers numerous benefits. For growers, the benefits include:

  • Higher profit margins – The creation of additional marijuana based products in-house allows growers to capture a percentage of the profit margin that is paid to companies further downstream
  • Steal shelf space from your competitors – By developing your own branded extract and concentrate products, you can offer dispensaries a wider array of products. This allows you to steal shelf space from your competitors
  • Less reliance on current customer base – The introduction of your own branded extract could reduce your reliance on your current customer base. In other words, diversifying your product offerings has the potential to diversify your customers. This reduces the financial impact of losing a single customer and gives your more negotiating leverage with said customer.

For dispensaries, the benefits of vertical integrations include:

  • Higher profit margins – The creation of your own branded products allows you to capture a percentage of the profit margins that your suppliers are currently making from you
  • Tailored products that meet your quality standards – Making your own line of products in house allows you to tailor your products to your customer’s specific needs and provides you with certainty around the quality of product
  • More opportunities to differentiate from competitors – Developing your own line of products also allows you to carry a product line that no other dispensary carries. This helps ensure that your customers keep coming back to you for repeat business and allows you to steal foot traffic from other stores
  • Less reliance on suppliers – Having the capabilities to produce your own branded products reduces your reliance on suppliers. In other words, if you can produce your own extract or concentrate you are less beholden to your current suppliers of these products.

Key Considerations before Vertically Integrating

Before your company dives right in to vertical integration, there are other things to consider. First, does your state allow vertical integration. Most states allow vertical integration in some form but some states such as Washington have outlawed vertical integration within the recreational space. 

Another key consideration is whether or not you can handle the complexity that comes with vertical integration. Although vertical integration can lead to higher revenue and higher profit margins it also adds additional complexity to your business model. It will likely require you to hire additional people and invest in new equipment.

One of the final considerations is whether or not vertical integration will put you in direct competition with your customers or suppliers. In most situations, it will put you in direct competition. Business owners need to assess the potential impact of this competition on their relationships with their customers and suppliers.

Next Steps
Above we have outlined some of the key benefits and considerations related to vertical integration. In our opinion, the potential for higher revenue and margins often outweighs the additional complexity associated with vertical integration. Please contact us to learn more about out our extraction machines and how you can invest in taking the first step toward vertical integration.

  • Kennedy, Bruce. “Colorado drags down national marijuana prices in first half of 2017.” The Cannabist, 2 October 2017. Web. 16 January 2018.
  • Cannabis Benchmarks Weekly Report – January 12, 2018.” Cannabis Benchmarks, 12 January 2018. Web. 16 January 2018.
  • Schaneman, Bart. “Washington state cannabis oversupply spurs calls for change.” Marijuana Business Daily. 10 January 2018. Web. 16 January 2018.
  • Arcwiew Market Research. The State of Legal Marijuana Markets Mid-Year Update. Arcview Market Research in partnership with BDS Analytics. 2017. Print. 5th Edition.