By Eric Vengroff, Financial Analyst, Cannabis Daily
Over the coming months and perhaps beyond that, you may hear the term ‘vertical integration’ be discussed in the same sentence or paragraph as cannabis.
Vertical integration is when a company controls more than one stage of the supply chain. For example, if a business that is manufacturing a product decides to get into the business of distribution or retail, they are moving downstream in the supply chain towards the consumer. If the business decides to get into the business of producing one or more of the raw materials that go into the manufacturing process, they are moving upstream in the supply chain towards the original commodities that go into the product.
When I worked in the carpet industry many years ago, the business we owned operated retail stores across the U.S. and Canada. When an opportunity came around to buy a carpet mill, the business decided to move up the supply chain and started producing the carpet that went into our stores. When another opportunity presented itself to buy a yarn spinning plant, the business moved up the supply chain once more to produce the yarn that went into the carpet that went into the stores. Further moves up the supply chain to produce the synthetic fiber that went into the yarn or drilling for oil that went into the petrochemical factory that made the fiber would have been costly and would have strayed into endeavors where the business had neither the capital or the expertise, and so we stopped there.
How will vertical integration apply as it pertains to cannabis production and retailing? In Canada, there are five provinces where retail distribution will not be handled by a government-owned monopoly, or outgrowth of their alcohol distribution system. Of the five, one province, British Columbia has said that they will not permit the licensed producers to also be licensed retailers. The remaining four – Alberta, Manitoba, Ontario and Newfoundland & Labrador, have stated that vertical integration will be permitted.
In a recent interview given by Bruce Linton of Canopy Growth at the MJBizCon Int’l event in Toronto, he said that he believed vertical integration was going to be good for the Canopy, as it will allow his company to open up stores and move margin around between the manufacturing and the retail businesses. This sounds like a great idea; we used to do this in the carpet business when it suited us. However, we didn’t have the provincial government inserted into the middle of our supply chain as the sole distributor, as will be the case, as I understand it, with cannabis.
In provinces where independently operated retail stores will be permitted, the sole source of retail supply will come from the provincial government alcohol distribution apparatus. The prices for the products will be set by the provincial government. Licensed producers looking to sell into the recreational market will only have one customer to sell to. Therefore, it seems likely that that one customer will tell the LP how much they intend to spend acquiring the products. I don’t imagine that there will be much bargaining leverage that the LP will have. I could be wrong…
As the provincial governments start acquiring product to fill up store shelves in the fall, perhaps a clearer picture will emerge regarding vertical integration. The financial statements of some of the LP’s who are engaging in their own retail distribution will be interesting to follow as well.
The information and opinions presented here are that of the author and do not represent the thoughts and opinions of this website. The analyst does not own and does not represent any of the companies listed in this article and receives no compensation from any party mentioned in this article. Readers are urged to do their own research and due diligence and should seek advice from an independent financial advisor before making any financial investment.