With recreational marijuana legal in Ohio and sales expected to start soon, how will the business of growing, cultivating and selling cannabis shape up?
There may be companies that specialize in one aspect. Retailers who do nothing but sell, for example.
But for businesses that can navigate state licensing rules, and have diverse expertise, a seed-to-sale vertical integration model might offer efficiencies, and more profit. At the same time, the model requires more licenses, paperwork and compliance measures, and a company that can operate multiple businesses simultaneously.
Ohio cannabis company Standard Wellness is an example of a vertically-integrated player in Ohio, with dispensaries in Sandusky, Springfield and Cincinnati, along with a cultivation/processing facility in Sandusky County.
Standard Wellness Vice President of Revenue Michael Wells said complete self-sufficiency has been the goal since inception, considering compliance costs cut deeply into profit margins and prohibitive IRS rules present other obstacles for companies that aren’t self-sufficient.
“We felt we were bringing a unique spin to the industry,” Wells said. “In the way we were focused on data, production planning and other details that sometimes get overlooked. We believed we had a specific skill set that would make us stand out in the market by being responsible for all elements of the supply chain.”
Such a streamlined approach is prompted by limitations other industries don’t face, Wells said.
As federal law still deems cannabis a Schedule I controlled substance – putting it on the same legal plane as heroin - the Internal Revenue Code forbids even licensed marijuana entrepreneurs from deducting regular expenses, such as payroll and rent, from their gross income.
State law further limits how big the operation can be. Level I cultivators are allowed 25,000 square feet of growing space by the Ohio Department of Commerce, while a Level II license can only have 3,000 square feet of space. In this restrictive environment, Wells said, companies need every ounce of control they can get.
“For example, anybody that doesn’t have a cultivation license has no control of what types of strains they’re growing in their facility,” he said. “We are constantly looking for the next exciting genetic. Anything that’s highly sought after won’t be offered in that third party or bulk market.”
All for one
A single business owning multiple segments of the supply chain can shrink overhead considerably, said Zuber Lawler attorney Jim Ickes, who has been guiding medical marijuana startups along the path of company formation, application and licensure for eight years.
By producing its own products, a vertically integrated enterprise may create more efficient cultivation and warehouse spaces, simplify packaging and downsize packing facilities, said Ickes, whose practice is in Cleveland.
Flexibility is another benefit of seed-to-sale control for companies eager to experiment with new products, procedures and cultivation methods. Implementing new ideas could result in lower production costs that get passed on to the customer, experts say.
“We represent other folks who are not vertically integrated, and that’s quite challenging in trying to work with competitors to bring products to market,” Ickes said. “If you want to develop a pre-roll of some sort, and you’re a dispensary, you have to coordinate with a cultivator to find flower, then you have to find a processor to process that for you. That’s all wedded together by contracts – when you’re vertically integrated, you own it all.”
Making educated decisions around vertical integration also requires understanding the drawbacks, said Zuber Lawler partner Janet Jackim, who works with cannabis entrepreneurs in her home state of Arizona.
From a cost perspective, developing a closed-loop cannabis business is akin to setting up multiple companies simultaneously. In Ohio, you also need separate licenses for each sector of the business, meaning you’re paying the application and license fees as well, said Jackim. Procuring a dispensary license alone in the Buckeye State can cost between $50,000- and $100,000.
Federal regulatory rules also have forced cannabis growing indoors, a pricey proposition where owners may spend $250,000 on a single smoke extraction machine. Meanwhile, an increasingly crowded marketplace means retailers have to spend big money on dispensary layouts, Jackim said.
“Dispensaries are getting really jazzed out – some of them are like Tiffany-showcased stores with very expensive casing, lights, mirrors, sofas and all of that,” said Jackim. “I know one dispensary that has a video projected against a wall 24/7 – somebody had to pay for that.”
Just the beginning
As farming, retail and production are vastly different areas, vertically integrated businesses will need to hire separate teams to successfully integrate across the supply chain, said Ickes.
Companies going vertical simply need money, both for day-to-day operations and the acquisition of diverse talent. But such a “cash-is-king” environment does not favor small businesses and minorities seeking retail ownership, Ickes said.
Under Issue 2, the statute approved by Ohio voters last year, a dispensary owner can have up to eight adult-use retail locations, said James Crawford, public information officer with the Ohio Department of Commerce, the governmental body tasked with licensing medical marijuana entrepreneurs.
A vertically integrated business needs a variety of licenses, he said.
“There are entities that hold licenses across the supply chain, which in many industries is considered vertical integration,” Crawford said in an email. “Regular inspections are conducted at licensed facilities, including a full compliance inspection for each renewal period.”
Ickes expects the vertical integration model nationwide to expand with the industry. Cannabis businesses like the San Francisco-based Cookies have already added consumption lounges and hospitality services to their seed-to-sale structure.
Even a more restrictive marketplace like Ohio’s could emulate that growth, Ickes said.
“I imagine there will be cross-pollination in all these business segments, but eventually, there will be a stasis point where competition and duties to shareholders force companies to stick to core competencies,” said Ickes. “Until then, there will be a great deal of experimentation, which will be thrilling to watch."
