DEA Reclassification of Cannabis Raises Regulatory Questions for States

LOS ANGELES- The U.S. Drug Enforcement Administration (DEA) has initiated steps to reclassify cannabis, potentially shifting it to a status similar to regulated medicines such as Tylenol with codeine or some steroids. This federal change could significantly impact the 26 states where cannabis remains illegal, prompting them to decide whether to ban its sale or establish regulatory frameworks for the now-legal substance.

Several states, like North Carolina, have pre-existing laws that will automatically legalize cannabis upon federal reclassification. Meanwhile, states such as Colorado and Washington have been managing cannabis markets for over a decade, offering potential lessons for states new to regulation.

Regulatory Models: Colorado vs. Washington

In 2012, Colorado and Washington became the first states to legalize recreational cannabis. However, their approaches to regulation were notably different. Colorado adopted a more competitive model, allowing unlimited licenses for cannabis retailers, which in theory should lead to lower prices due to competition. Washington, on the other hand, restricted the number of licenses and kept prices higher to discourage overconsumption and its associated societal costs.

Despite Colorado’s more open market, by 2022, cannabis prices were slightly higher there than in Washington. This is due to key differences in how these states regulate the cannabis market, particularly in licensing caps, the size of allowable businesses, and vertical integration.

Market Structure and Licensing Caps

Washington limits the number of dispensaries to 556 statewide, approximately 4.8 per 100,000 residents. By contrast, Colorado has 680 dispensaries, or about 14 per 100,000 residents. While Colorado’s market may seem more competitive based on the number of licenses, its regulatory framework favors larger chain companies, creating less market diversity and potentially higher prices.

Big Chains vs. Small Businesses

Washington restricts the number of licenses a single cannabis business can own—capping each business to five dispensaries and a limited number of growers and processors. This favors small businesses, with an average of 1.24 licenses per company. Colorado, however, allows businesses to own multiple dispensaries and production facilities, enabling large cannabis chains to dominate the market. For instance, the chain LivWell operates 24 dispensaries across Colorado, benefiting from economies of scale that disadvantage smaller independent businesses.

Vertical Integration and Pricing

Vertical integration—where a company controls production, distribution, and retail—plays a significant role in price dynamics. Colorado initially required cannabis businesses to be vertically integrated, which reduced the risk of black market products entering the legal supply chain. Although this requirement was lifted in 2018, many companies continue to operate under this model. Vertical integration typically leads to lower prices by reducing intermediary markups. However, it can also drive out small competitors, reducing market competition and potentially leading to higher prices over time.

Washington, on the other hand, prohibits vertical integration, following a regulatory model similar to the alcohol industry. This ensures that separate entities control growing, processing, and retailing cannabis, creating a more fragmented but regulated market.

As other states prepare to regulate cannabis following the DEA’s reclassification, Colorado and Washington’s differing approaches offer valuable insights. States will need to balance consumer access, public safety, and market competitiveness when developing their regulatory frameworks. The experiences of these early adopters suggest that market concentration, licensing caps, and vertical integration are key factors that will shape the success of future cannabis markets.