Statistics Canada reported last week that cannabis sold for $6.77 per gram nationwide in the second quarter, down 7% from 12 months ago.
87% of supply is sold on the black market with the rest going through legal medical channels.
Black market prices are now down 18% in 3 years and at the current pace they will undercut legal prices by over $3.50 per gram when Canada goes legal on October 17.
Legal retailers are going to ask consumers to pay a big premium to black market prices and the big question remains: Will consumers open their wallets?
Recent consumer surveys may provide the answer…
Canopy Growth and Canada Retail Prices Compared
Source: Statistics Canada, SEDAR
A Parliamentary Report Could Provide Some Clues
In 2016 The Canadian Parliamentary Budget Office (PBO) released analysis estimating the percentage of Canadians who will pay a premium for legal cannabis compared to black market prices.
The data from a Washington State consumer survey initially looked very promising with 50% of users reporting they would pay at least $5-$10 more for legal marijuana and another 30% willing to pay $1-$5 more.
Price Premium is the Vertical Axis and % of Users Willing to Pay the Premium is the Horizontal Axis
The problem with the chart above it that it only looks at the percentage of smokers who would pay a premium, not the volume they would buy at each price point.
According to a recent study on the Colorado market, heavy users are only 25% of the population but buy over 80% of marijuana sold.
PBO consumer data agrees with the findings in the Colorado report.
Heavy users are the customers that matter.
Heavy Users Purchase 82% of all Marijuana, but are only 25% of the population
Source: University of Colorado, MPG
If we look at the same government survey, but only for daily users the responses are more concerning.
Only 36% of heavy users would pay a $5 premium for legal supply and even if the price premium was only $2 higher, only 50% would switch to the legal market.
If these responses are accurate, almost half of the amount purchased will remain in the illicit market if the legal price is even $2.00 higher than the illicit market.
Daily Users’ Willingness to Switch to the Legal Market
Source: PBO
Based on Canada’s proposed tax framework and initial retail pricing, legal prices will be $3.00 – $4.00 higher than illicit, implying 60% of volumes will continue to be bought on the black market.
% of Volumes Purchased Legally Depending on Black Market Price
Source; PBO
What Can Legal Retailers Do?
Because of restrictive advertising and packaging regulations, licensed producers and retailers will have to beat the black market on price, selection, service, and safety.
Price
Legal marijuana will always cost more than illicit market supply.
Drug dealers don’t pay taxes, postage, or licensing fees and they generally don’t run large brick-and-mortar retail stores with rent to pay, utilities, and employee salaries to worry about.
Pricing is one area where the legal market will always lose.
Selection
This is where the legal market has the best chance to win over the black market, but only after edibles and vape pens are legalized in October 2019.
Access to cutting-edge research, manufacturer and processing technology will lead to new cannabis products the illegal market just can’t copy.
Infused beverages, edibles, pharmaceutical grade pills, beauty products, vitamins, and more.
Providing consumers with a discreet and novel way to ingest cannabis will go a long way to convincing long-time customers of the black market to switch sides.
Service
The average Canadian black market seller already provides local service and reliable, free delivery in many cases.
The legal market will have to go one step further by providing the same conveniences, but with a comprehensive educational component as well.
Consumers are not only used to cheap and fast delivery, they also expect to have access to all the information they need to fully understand what they’re buying.
If the legal market succeeds in educating consumers they have a better chance of creating repeat customers who value the information and personal service a legal in-person retail experience can provide.
Safety
The lack of easily accessible public information confirming the increased safety of legal cannabis is a big public policy misstep in our view.
Illicit cannabis is filled with illegal pesticides and industrial carcinogens such as butane and propane left behind during the refining process.
Legal cannabis, if regulated correctly, will provide a much healthier option for consumers.
The clear health advantage of legal cannabis over the illicit market will be one of the strongest marketing tools to convince consumers to buy legal.
Investors are Setting Themselves up to be Disappointed
After the recent out-performance of cannabis stocks, the 10 largest producers have a combined market capitalization of $36 billion.
Assuming an earnings multiple of 20x, in line with high growth companies, cannabis investors are assuming the top 10 companies alone will sell over 1 million kg annually.
This is 1.5 times as much cannabis as Canadians consume in a year.
One million kgs of legal sales would mean the legal market completely destroys the black market in less than two years, a feat never before accomplished in the history of legalized cannabis.
Investors are betting their life savings the legal market will deliver a swift knockout blow to the black market.
Without a consumer stampede into online and offline retail stores beginning October 17, investors may be sorely disappointed.
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