Oh Cannabis, An Industry Is Yet To Land…

TORONTO—It didn’t have to be this way. I mean, in spite of what so many whinge and whine about, Canada had a lot to leverage.

• Canada is pretty big, with a population of about 40 million
• Canada is pretty vibrant, with a GDP of about $5.8 trillion
• Canada is relatively affluent, with a median disposable income of ~$61,000
• And, maybe most importantly, Canada was among the first – the first G7 nation to federally legalize recreational cannabis (Uruguay legalized in 2013, but it’s a much smaller market)

So Canada, it would seem, was poised to become a very profitable place in which to grow and sell legal cannabis…

…until, it wasn’t… and, it still isn’t.

What Happened?

It started on October 17, 2018. That was the date that recreational cannabis became legal in Canada. Medical cannabis had been legal since 2001, although it has gone through a number of iterations, from the government running it, to it now being run by private companies.

So, many of the players you now read about in Canadian cannabis, got their start in medical – Canopy Growth, Aurora Cannabis, Tilray, Aphria (now part of Tilray), Hexo (now part of Tilray), Organigram…

… and when the Liberals won a majority federal government in the 2015 election, legalization was one of their platforms… it was going to happen.
And over the next 3 years, the industry began to take shape… pear-shaped, unfortunately.

There was a lot of information – the Parliamentary Budget Office of Canada put out a very robust econometric forecast on consumers and usage and sales in November 2016. The federal government put together the Task Force on Marijuana Legalization and Regulation, who released a 106-page report to the public in December 2016.

And, in Canada, we had another view into how it might be regulated – beverage alcohol. An industry where the 10 provinces oversee the retailing. A mix of government-run stores, privately run stores and hybrids of both. Complex and subject to change (in Canada’s largest province, Ontario, bev-alc retailing has been undergoing significant change under the Conservative government). Regulations on advertising. High taxation.

Show Me The Money
While this was happening, cannabis companies were applying for licenses to grow and sell legal recreational cannabis. According to Statistics Canada, there were 83 licenses granted to produce cannabis in 2018. Investment spending increased to $233 million in 2017/2018. Total assets had risen to $2.5 billion by the end of 2017/2018 and had increased further to $4.2 billion by the end of 2018/2019.

And that money had to come from somewhere, and that somewhere started with the retail investor. Companies had started to flip from private to publicly-traded, to both access the public markets and to use it as a pseudo advertising vehicle (given traditional advertising was prohibited). Canopy Growth (then, called Tweed Marijuana) IPO’d in April 2014. Aurora Cannabis went public in 2017. Many others followed.

But it all went exponential when Constellation Brands came knocking, with a bag full of money. October 2017, STZ invests $245 million into Canopy Growth.
Instant credibility.
And then, they up the ante – in August 2018, less than a year later, they announce a (gulp) $5 billion investment in Canopy. This is followed up by a $2.4 billion investment by Altria into Cronos Group, in December 2018.

And the spending, it started… boy oh boy, did it start.

Newly opened Cannabis Store sign in Mall

It was led by Canopy Growth and its charismatic CEO, Bruce Linton. Linton began a buying and building spree, many would say, inspired by Amazon’s “Get Big Fast.” Canopy invested in what the industry called “funded capacity” – this meant lots of indoor and greenhouse and outdoor grows. A lot. Canopy reported having almost 6 million square feet of growing capacity in Canada, months before federal legalization even went live. This was met by competing capacity investments by Aurora (Sun, Sky, Vie, Eau…) and Hexo and Aphria and Tilray. Far more capacity and resultant supply than the demand could ever cover.

And it was matched by similar investments around the world – Africa, Europe, South America… Canadian cannabis companies were going to rule the world.

And then, reality struck.

Federal legalization happened and, well, the financial performances of these companies started to hit – hit the fan, as it were.

They were not good – massive losses. But, OK, it’s still early and it takes time to build a market, an industry and profitable companies therein.

Too much capacity = oversupply = downward pressure on pricing = reduced margins.

So, the losses just kept coming. And companies were getting acquired, to help prop up the topline, create news and excitement and spin it as an indication that the acquiring company was doing well (they were buying other companies, so they must be doing well). Instead, the added costs and complexities just added to the woes…

… fast forward to 2023 – a Miller Thomson study found that investors had lost a total of $131 billion, or $43,000 per investor. Few, if any, publicly-traded cannabis companies had ever turned a quarterly profit and none were sustainably profitable. Share prices were plummeting.

It was not looking good, and as we finish 2024, it is still tenuous, although, a few cannabis pubcos are starting to show signs of profit potential. Cannara Biotech and MTL Cannabis are two Quebec-based cannabis companies who have released promising financials over the last few reporting periods.

Insolvencies continue – higher profile retail companies like Fire & Flower and Tokyo Smoke have filed for creditor protection. Hexo, a former media darling on which the book “Billion Dollar Start-Up” was based, went from a billion-dollar market cap to de facto bankruptcy and were bought by Tilray.

Canada is a $5 billion retail cannabis market – while sales are showing signs of slowing and moving more toward legal consumption age population growth, it is still a major industry.

It’s just not a profitable one…

… Canopy Growth has lost over $10 billion. Aurora Cannabis over $6 billion. Tilray Brands approaching $3 billion in losses in just the past 3 years.

Lessons Learned… If Anyone Was Paying Attention

Back in 2015, I approached the Canadian Cannabis Council to pitch an idea – pool the members funds to field a syndicated consumer segment study. Rather than have companies do it themselves, do it once, do it well and reduce the per member cost… may the best users of the data win. It was crickets and tumbleweeds – no interest. Why invest in the consumer when you can sell as much as you can grow, was the thinking. This and the belief that the strict regulations made a consumer-driven business unattainable.

In truth, there is a list of the Top 10 Things You Should Know As You Run A Recreational Cannabis Company in Canada:

1. Rec cannabis is a consumer packaged good – that’s how the consumer views it. Think more about categories like wine or cheese or coffee or scotch as parallels. Product categories where there are consumer segments who are deeply engaged and knowledgeable, but, also those who consume Kraft Singles and Maxwell House. But if you choose a consumer segment, take the time to understand them and build a value proposition and value equation (what it does, for what it costs) that resonate, you have a fighting chance.
2. Legal cannabis has and will continue to have a lot of government involvement. That means politics play a big role in how it’s regulated. If voters care, they care – if not, they care less.
3. Let Scale lag Sales, as opportunity costs are a lot easier to eat than real costs. If you have a winning value proposition, the consumer will switch to you when you get there – they’ve been doing it for a hundred years.
4. Keep as much of your commercialization process variable cost as you can, until your value proposition is fully proven and the market/regulatory line of sight becomes clear and predictable. Then, and only then, should you really look to capitalize the processes.
5. Focus – apply a proven strategic framework like Playing to Win – Where to Play and How to Win. And be disciplined in its application.
6. There are only 3 ways to increase profits
   a. Sell More – penetration vs share of requirements
   b. Increase Prices – look to elasticity of demand
   c. Cut Costs – but only the ones that don’t add value
7. Strategy drives Structure drives Staffing – apply this cascade to how you develop and deploy your winning value proposition and how and who the people in the company action and support it.
8. You need to embrace both the future and the past – you don’t need to come from the legacy market, but you should understand it and respect elements of it. There are things to be learned from it. Don’t be afraid to hire from it, to build the best overall team.
9. Export from Canada has an expiry date – Quality, Quantity, Cost and Provenance are the 4 levers of a sustainable export business and flogging flower from Canada will end up hitting a wall of protectionist policies in importing countries and more formidable competition.
10. WWHTBT – What Would Have to Be True? Apply this to your go forward business planning. Be realistic – it’s a competitive market. As you build your plan, ask yourself 2 questions:
    a. What is the most likely competitive response to this?
    b. What would be my response to that?

And, it’s game-on…

Copyright © Highly Capitalized Network and Rob McPherson. All Rights Reserved. The editors wish to thank Rob McPherson for his opinions in this article. Rob spent 25 years in consumer-packaged goods, with companies like Procter & Gamble, Sandoz, Kraft Foods and Bacardi Limited, in both regulated and non-regulated categories. His last role was President of Bacardi Canada. He spent 5 years consulting to the cannabis market and now operates a Substack paid subscriber service, analyzing Canadian cannabis companies and providing tutorials on business strategy, consumer segmentation and brand development. Main image: Rob McPherson, courtesy of Rob MCPherson.