What went wrong in Canada’s cannabis industry?

Assumptions around demand, crossed with investor groupthink, saw the nascent Canadian cannabis industry prioritise production scale over understanding or creating a market that could scale.

As an exploration of the market in the Canadian current affairs magazine The Walrus explains, several early mistakes across the industry have limited its potential.

Why it matters

Not known for a corporate-friendly, conformist approach, marijuana enthusiasts in Canada haven’t taken to the large, corporate, quasi-pharma firms that hoovered up the frothy investment interest ahead of the legalisation of recreational cannabis, which began in 2018.

While small producers are now cropping up and showing the way to a sustainable local market, large companies are finding that price-conscious consumers, and few robust brands, mean sustainable profits are still further away.

Background

Projections in 2018 anticipated sales of cannabis would top $6.5bn by 2020. But even with a pandemic that kept people at home twiddling their thumbs all year, Canadians spent just $2.6bn on these products.

Worse still, people are still buying from the illegal market that the legalisation effort was supposed to quell, as just over half of all sales come from the legal market. A related outcome: huge amounts of regulated product is now going to waste.

What happened

• On an investment front, a nascent industry tends to attract attention, but the cannabis business was uncommon in its interest from retail (that is, individual or non-professional) investors.
  
  But a lack of reliable metrics around likely sales meant that cultivation potential – how much a producer could cultivate on their land – became the focus. Bigger production facilities thus drew more investment, and investment went toward bigger producers.
  
  Once the legislation came into force, early product shortages – and the intense news interest in the industry – reinforced the idea that production capacity was crucial to any respectable cannabis business. And, by 2019, oversupply issues began in earnest.
  
• Overconfidence was also a problem. A lot of the people running these young companies had backgrounds in tobacco and alcohol, which are relatively stable commodities, and believed their knowledge and skills were transferable. In reality, prior to legalisation, no one really knew what cannabis consumers wanted, or what prices they would be willing to pay.

What’s happening now

• The industry is beginning to pivot away from the previously expected economies of scale, especially as none of the large companies is yet profitable.
• Smaller producers are getting licences and producing in the style of small-batch craft breweries. While distribution is a struggle for these players, mergers are expected. And, at a local level, there are signs that this could work.
• Large producers like Tilray, which announced its fourth quarter results last week, have noticed that an expected premiumisation that’s taking place in the coffee and alcohol markets, fuelled by home workers’ pandemic savings, hasn’t happened for cannabis. Basically, this is a price-sensitive category on the whole, driven by a pandemic era shift to e-commerce.
• A Stifel study of US and Canadian users also identified that turnover between brands was extremely high, meaning that, despite the big boys’ chunky marketing budgets, there are few brands that people are loyal to.

Sourced from The Walrus, Bloomberg, The Street