The Marijuana Act, introduced on April 13, 2017 was created with two goals in mind:

  • Protect public health by restricting youth access to marijuana and allowing adults to possess and access regulated, quality controlled legal marijuana by requiring strict product safety and quality requirements.
  • Deter and reduce criminal activity, by legalizing and taxing the cultivation, distribution and sale of marijuana.

The language in the act treats public health and safety as the number one goal for recreational legalization and is influencing what public distribution method will win out in the end.

The regulatory landscape in Canada is still in flux, but provinces have recently begun deciding how cultivation, distribution and retailing will take place. A few main themes in marijuana regulation have appeared.

 

No Vertical Integration

Legal producers (LP) will not be able to control all aspects of the supply chain, from growing to distribution to consumer sales. They will have to sell all supply destined for the recreational market to the government.

Recent leaks of ongoing negotiations point to a $3.50-$4.50 per gram price point the government is willing to pay to licensed producers for dry marijuana.

This is much lower than what the marijuana equities are pricing in as of July 2018.

Online Sales of Medical Marijuana Will Remain

The government will still allow legal producers to sell to medical patients through existing internet portals. This is a positive outcome for the LPs’ ability to differentiate their medical products. Individual online storefronts allow more flexibility in labeling and branding and provide an opportunity to stand out from the crowd more than in a retail store. Pricing power will be limited, however, because the government will set reimbursement rates, which will keep a lid on prices.

 

The Government Will Be the Only Distributor

The theme among provinces is to designate the government as the sole wholesale buyer and distributor of marijuana products. The government wants to maintain control over the supply chain, and as much as possible, keep black market supply from entering the legal retail system.

 

There is a Light at the End of the Tunnel for Legal Producers

Once the black market is marginalized, legal producers could begin to generate attractive returns. Without an alternative source of marijuana, consumers are a captive audience and will be forced to pay retail prices that may be higher than what a competitive market would require. The private suppliers to government-run liquor and beer stores enjoyed very strong margins for years because of the distribution monopoly created by the government.

 

Bottom Line

Legal producers are being forced into a wholesale-only model. They will have little pricing power due to the government’s control over retailing and distribution. As long as the black market is a significant source of supply, the government will have to keep prices down to make sure consumers switch to the legal market. Lower margins from lower prices will have to be eaten by the legal producers as the government is not willing to give up tax revenue to benefit private industry.

The speed of the supply transition from black market to legal marijuana is uncertain, and in the interim, the legal producers could be operating in a very tough environment competitively.

RETAIL STRUCTURE BY PROVINCE

 

Ontario (38% of Canadians)


Retail – Private and Government

Online – Government only

Grow your own – 4 plants

Legal Age – 19


The Ontario government is poised to announce either a completely private or private and public retail distribution model. The government will be the only distributor and will have a monopoly on purchases from licensed producers and will exclusively handle storage and transportation to retail stores. Edibles and flavored extracts will be banned at least for the first year of legalization.

The government plans to open 40 stores by October 17th 2018 and 80 by July 2019 with a goal of 150 stores by 2020. This is far less than the 660 LCBO stores currently supplying alcohol to Ontario. Ontario has a population of 14.2 million and each of the 40 stores will need to serve 340,000 people, virtually ensuring long lines initially.

LP Impact

Growers are effectively wholesalers under this model. They will have to accept the price the government wants to pay as the government is the only legal customer. The government is likely to let retailers set their own prices, but could set a minimum price like B.C. The government’s job will be to make sure retail prices are low enough to undercut the black market and maximize government tax revenue. When retail prices start falling, as we expect, the government will keep its take the same and growers will be the ones taking a margin hit.  

 

Quebec (23% of Canadians)


Retail – Government only

Online – Government only

Grow your own – NO

Legal Age – 18


Quebec forbids citizens to grow their own plants, at least for now.

The government will run the only licensed retail stores and will also have full control of the online distribution of recreational marijuana. The government will have a monopoly on purchases from producers and will exclusively handle storage, transportation and sales of marijuana. Edibles and flavoured extracts will be banned for at least the first year of legalization. Quebec forbids citizens to grow their own plants, at least for now.

LP Impact

LPs are effectively wholesalers under this model. They may have some freedom to set the price they charge the government, but the government ultimately will decide what the retail price should be at government-owned locations. Producers will be the ones taking a margin hit, not the government, if prices charged to consumers are lowered.

 

B.C. (13% of Canadians)


Retail – Government and private

Online – Government only

Grow your own – 4 plants

Legal Age – 19


Marijuana cannot be sold next to liquor, except in rural stores and there is no restriction on pharmacies selling marijuana, unlike in Alberta.

The final market structure is going to include a mix of public and private retail storefronts. The government will be the only supplier to retail outlets and will also handle distribution province-wide. Marijuana cannot be sold next to liquor, except in rural stores and there is no restriction on pharmacies selling marijuana, unlike in Alberta. The government will handle online recreational sales as well.

LPs can own retail marijuana shops, but if the business relationship is too close, the province will prohibit the producers from selling their own supply in their retail stores. This should discourage LPs from owning retail stores unless they can find legal loopholes to sell their own supply at the stores they own.

A person or company may have an interest in both a producer and a retailer. However, the LCLB will place restrictions on the business relationship between the producer and the retailer. Where there is a close association (financial or otherwise) between a licensed producer and a non-medical cannabis retail business, the retail business will be prohibited from selling any products from the licensed producer. This restriction ensures that the market remains diverse and larger participants do not consolidate and control the market. The Province may create exceptions in the future to support micro-producers.  – B.C. Retail Licensing Guide

LP Impact

If LPs could grow marijuana and sell it out of their own retail stores it would be a best-case scenario under the planned marijuana regulation. However, with the restriction on inter-company deals, LPs are restricted to a wholesale role. Owning a retail store looks to provide little branding or marketing benefits seeing as LP’s are not able to sell their own products in the stores they own. Running a retail store enables a producer to turn a profit, if done right, but doesn’t pass on many other benefits to the company as a whole.

 

Alberta (12% of Canadians)


Retail – Private (licenses producers allowed)

Online  Government only

Grow your own – 4 plants

Legal Age – 18


Pharmacies, liquor stores and stores selling tobacco will not be licensed to sell marijuana.

The government will handle wholesale, distribution and online sales, while retail stores will be privately run. The government will be the only buyer of marijuana from growers and then will set the selling price to private retail stores. The privately-run stores will then be able to set the price they charge consumers. Pharmacies, liquor stores and stores selling tobacco will not be licensed to sell marijuana.

The taxing scheme has not been revealed yet, but it will be a combination of the government excise tax at the wholesale level and a sales tax at the retail level with potentially a distribution margin thrown in by the provincial government.

LP Impact

Alberta will be the largest province to allow licensed producers to own retail stores.

LPs are effectively wholesalers under this model. They may have some freedom to set the price they charge the government, but the government can mandate a minimum selling price and will ultimately will decide what the retail price should be by regulating the wholesale price charged to retail stores. Producers will be the ones taking a margin hit, not the government, if prices charged to retail stores are lowered.

Private retailing will provide more freedom for the LPs in how their products are marketed and labeled in the stores, but because the government still stands in the middle as the distributor, flexibility will be limited.

Alberta will be the largest province to allow licensed producers to own retail stores. The producer will have to establish a separate legal entity with different management, but effectively they can sell their own marijuana directly to consumers.  A private retail model will give producers slightly more freedom to differentiate their products though government regulation of packaging and labeling is extremely strict.

Ultimately, this is a similar model to the government-run retail stores in Ontario, however, the government will have less control over the price paid by consumers.

 

Manitoba (4% of Canadians)


Retail – Private (LPs allowed)

Online – Government only, but open to private sales

Grow your own – NO

Legal Age – 19


Manitoba recently permitted two legal producers (Delta 9 and Canopy Growth) to open their own retail stores, one of the two provinces to allow this.

The government of Manitoba is using the Alberta model where the government will buy marijuana from licensed wholesale growers and will be the only source of supply for privately run retail locations. Anyone can obtain a license to open a retail dispensary, but they must purchase their supply from the government. The government will handle storage and transportation of marijuana from the wholesaler to the retailer. The government’s goal is to price wholesale marijuana to undercut the black market and to make sure supply grown in province is not diverted to the black or grey market.

Manitoba recently permitted two legal producers (Delta 9 and Canopy Growth) to open their own retail stores, the only province to allow this. This is a unique structure that will give them the freedom to set retail prices and differentiate their products. We wonder how the government will keep Delta 9 from favouring its own supply in stores or choosing not to stock competitor products altogether. More details are likely coming.

The government will be the only seller online at first, but is open to allowing online sales which would be very positive for legal producers. Online storefronts would allow legal producers to differentiate their products and potentially choose pricing without the government’s input.

LP Impact

This is the best model the legal producers could hope for. They have the ability to open their own stores where they can set retail prices and choose how products are displayed to drive retail sales. Private retailing will likely afford the LPs more freedom in labeling and marketing so they can differentiate their products from other competitors.

The government still has some control over the profitability of private stores as they can set the wholesale price of the marijuana sold at retail. Private stores will have to price their products competitively to sell so if the government raises wholesale prices for instance, the retailer is likely the one who will have to eat the lower margin.

 

Saskatchewan (3% of Canadians)


Retail: Undecided

Online: Undecided

Grow your own: Undecided

Legal Age: Undecided (likely 19)


The results of a province-wide survey indicate consumers are split 50/50 on whether private or publicly run retailers should win out. Justice minister, Don Morgan, commented that he doesn’t think the province should be in the distribution business either, which would be a positive development for legal producers if they were allowed to handle the growing and sale of marijuana.

 

Nova Scotia (3% of Canadians)


Retail – Government Only

Online – Government only

Grow your own – 4 plants

Legal Age – 19


The government is going to have the exclusive right to sell marijuana out of existing government-owned liquor stores. They will also manage online sales and delivery. Nine government-run retail stores will be open by August 2018.

LP Impact

LPs are effectively wholesalers under this model. They may have some freedom to set the price they charge the government, but the government ultimately will decide what the retail price should be at government owned locations. Producers will be the ones taking a margin hit, not the government, if prices charged to consumers are lowered.

 

New Brunswick (2% of Canadians)


Retail – Government Only

Online – Government only

Grow your own – 4 plants

Legal Age – 19


The provincial government will set up tightly controlled, government-run retail stores. The government will also control online ordering. Supply agreements have been signed with four legal producers so far (Canopy, Organigram, Zenabis and Nuuvera).

LP Impact

LPs are effectively wholesalers under this model. They may have some freedom to set the price they charge the government, but the government ultimately will decide what the retail price should be at government owned locations. Producers will be the ones taking a margin hit, not the government, if prices charged to consumers are lowered.

 

Newfoundland and Labrador (1.5% of Canadians)


Retail – Private (LPs allowed)

Online – Government only at first, private sales to follow

Grow your own – 4 plants

Legal Age – 19


The government will have full control of the online and retail distribution of recreational marijuana. The government will have a monopoly on purchases from producers and will exclusively handle storage, transportation and sales to retail establishments.

Private retail stores will be licensed to sell marijuana provided by the province and in the future the province may begin giving out licenses for private companies to sell online as well.

LP Impact

This is the best model the legal producers could hope for. They have the ability to open their own stores where they can set retail prices and choose how products are displayed to drive retail sales. Private retailing will likely afford the LPs more freedom in labeling and marketing so they can differentiate their products from other competitors. Future online sales provide even more freedom and would be very positive for LPs’ brand differentiation.

 

Prince Edward Island (.4% of Canadians)


Retail – Government only

Online – Government only

Grow your own – 4 plants

Legal Age – 19


The provincial government will set up tightly controlled, government-run retail stores and will handle distribution and online sales.

Unique to the province, use of marijuana will only be permitted in private residences. Potential for expanding smoking to public spaces could be allowed at a later date.

LP Impact

LPs are effectively wholesalers under this model. They may have some freedom to set the price they charge the government, but the government ultimately will decide what the retail price should be at government-owned locations. Producers will be the ones taking a margin hit, not the government, if prices charged to consumers are lowered.