Ask Our Experts 08/12/2018

Q: In regards to the CannaBit on 7/21, showing a drop in flower prices and an increase in spending, what does this mean for overall sales revenue? Are consumers still spending the same amount of money but just getting more? Who is getting the short end of the stick here: Growers,retailers or both?

A:
Depending upon the state market — particularly those without licensing caps —prices for flower have experienced significant declines. In fact, overall prices for raw material inputs (such as trim for oil) in addition to flower have fallen in almost every market. Imbalances between wholesale supply and demand, and a saturation of retail outlets, are contributing factors in pushing prices lower.

Given that each market is different and has its own set of regulatory dynamics, the answer to the question is not as straightforward as it seems. However, in broad brushstrokes here are some observations.

Over a 12-month period from February 2017 to February 2018, retail flower prices in Oregon declined 26.3%, even though wholesale prices declined in an excess of 50%. Typically, on products that are elastic (such as cannabis), one would see a significant spike in sales when there is a price decline of 26%.  Yet in Oregon, the average transaction amounts held relatively constant (down only 6.2%), while the average number of grams sold increased 18.5%. Over that same period, the number of retailers in Oregon increased by over 50%, and total transactions increased by 35.8%.

What does all this mean in terms of any short end of the stick?

From the retail side: With wholesale prices dropping significantly, and at a faster pace than retail prices, retailers are often choosing to expand their margins, without passing price decreases to their customers. While understandable that they might try to maximize profits, those retailers may end up hurting themselves through that strategy once federal taxes come due. Retailers are unable to write off as many deductions as cultivators, so the higher margin revenues will be hit hard at the federal tax level due to IRS 280e. In addition, as consumers are price-sensitive, retailers who hold prices high to maximize revenues may end up losing their customers to other retailers choosing to reduce their prices in line with falling wholesale prices. By passing cost savings on to customers, retailers can drive more business as consumers convert from the illicit market.

Oregon is a good example of how lower prices will drive more conversions from the illicit market. Given that total retail revenues are up at the same time the average transaction amount is 6.2% lower, the only way to achieve it is through greater legal participation. Therefore, what the state of Oregon’s data shows is that lower prices result in greater conversion from the illicit market and greater legal participation.

Therefore, retailers who pass the wholesale price decreases on to their customers will increase the number of customer visits, and could increase revenues and profits through volume. Any retailers not passing costs on to their customers may end up with the short end of the stick.

From the cultivation side: Lower wholesale prices create challenges for higher cost producers, many of whom will be forced out of the market due to their inability to make any profits. For those cultivators who can stay ahead of the lower prices, they will still have a fight on their hands given an abundance of supply to work through, and a highly competitive market due to supplier saturation. As more and more suppliers fight for shelf space, wholesale prices will continue to decline until a balance is reached between the supply and demand.

Many cultivators are adjusting to changes among the market and consumer preferences by shifting production away from the flower-oriented market, and toward supporting the manufactured (or oil-based) market. Consumer preferences have shifted away from flower (once 72% of the Oregon retail market, it now represents about 50% of the market), and many cultivators have consequently shifted production to meet the demand. Though margins are shrinking for those products too due to lower prices for oil-based biomass, farmers remain able to survive on volume.

Some cultivators struggling to survive in the medical or social cannabis space are considering converting their crops to a more stable but growing industrial hemp market.

Are cultivators then left with the short end of the stick? For those who are well capitalized, there is tremendous opportunity when prices decline: to buy shelf space, capture additional market share, and acquire other businesses for pennies on the dollar. For those not well funded, however, the future is less bright.

Regardless whether being retailers or cultivators, those businesses that have exhibited cost controls and are in position to weather further price declines see great opportunity even now. Conversely, any businesses caught between higher costs and low margins have very little stick left to hold before abandoning their enterprises.