With every new market, comes an inevitable correction. California’s cannabis industry isn’t dying. It’s just not as large as people thought.

--- Disclaimer: HdL Companies is neither for or against the legalization of cannabis. HdL understands that the sale of legalized cannabis acts as a form of revenue for the place of sale, and therefore it is categorized under tax types that HdL offers revenue management services for. Learn more about HdL's Cannabis Compliance Services

 

Reports of the cannabis industry's demise in California have been greatly exaggerated.

California's cannabis industry is not dead, and it’s not dying; it’s just realizing that the market is not large enough to support everyone hoping to get a slice of the pie. After an initial over-zealous rush of growers, the industry is now contracting to match the true size of the market.  At its most basic level, the industry is consolidating to support the minimum level of production necessary to meet consumer demand. Cannabis has become a commodity, and that’s just the way commodity markets work.

cannabis cultivation in californiaIn 2017, the California Department of Food and Agriculture (CDFA) estimated the total amount of cannabis consumed by California residents to be roughly 2.5 million pounds per year.1 In January 2018, the CDFA began issuing cultivation licenses. Six months later, the state had already issued over 4,000 licenses capable of producing 8.4 million pounds of legal cannabis annually. That’s more than three times as much cannabis as all of California consumes in a given year.

At the start of 2023, there were 7,651 active cultivation licenses capable of producing over 16 million pounds of cannabis annually, and yet, only 2.4 million pounds of cannabis entered the commercial market in 2021.2 That’s just 15% of current production capacity. Logic would suggest that we could see a failure rate of 70% or more simply due to the current divide between supply and demand.

Cannabis licenseLet's break down those 7,651 licenses a step further... 

  • 7,651 licenses are held by 3,359 separate businesses.
  • Of these businesses, nine companies hold over 100 licenses each, encompassing more than 16 million square feet of cultivation area.
  • The largest of these companies holds 254 licenses, covering more than 2.5 million square feet.

Based upon rough estimates, the 20 largest cultivation companies are capable of producing over 2.6 million pounds of flower per year – enough to supply the entire statewide market. 

This is not unique to the cannabis industry. The brewing industry in the U.S. provides a good comparable. According to the Brewer’s Association, there are 9,247 breweries in the U.S., of which 9,118 are craft breweries. Despite their large numbers, these 9,118 craft breweries share just 13% of the total market.3 The wine industry provides another example. There are over 11,000 wineries in the U.S. Of these, the 50 biggest companies alone represent more than 90% of domestic wine sold by volume.4

Recent cannabis legislation is placing pressure on small-scale growers.

Unfortunately, recent legislative changes won’t make things significantly better for the cannabis industry. Last summer, Governor Gavin Newsom signed AB 195 which eliminated the state tax on cannabis cultivation. This was welcome news for the thousands of small growers who were struggling to stay afloat, but it was equally welcome news to the largest growers, who can now reinvest a greater share of revenue back into their operations to drive even greater production efficiencies. This could have the effect of further lowering wholesale costs, placing even greater competitive pressure on small-scale growers. 

The situation may get worse for small growers. As of January 1st, 2023, the Department of Cannabis Control (DCC) began issuing Type 5 “Large” cultivation licenses which will allow growers to cultivate unlimited square footage under a single license, rather than having to “stack” multiple 10,000 square-foot Type 2 licenses. The DCC expects that this change will result in consolidating 4,342 small and medium licenses into 348 large licenses, with an estimated annual savings in licensing fees and production costs of over $9 million dollars.5 Those savings will accrue primarily to the largest cultivators with the most licenses. As with the windfall from elimination of the cultivation tax, those businesses may use the savings to further reduce prices and increase market share.

humboldt county california cannabisOver the past year, numerous counties and cities across California have moved to reduce their local cannabis taxes in an effort to help their growers be more competitive. Humboldt County, historically the heart of California’s cannabis industry, slashed its cultivation rates by 85% to as low as 15 cents per square foot. However, 13 of the 20 largest growers are located in Santa Barbara County, where the local tax rate of 4% of gross receipts is effectively 16-times higher than in Humboldt. Some of these large growers are selling greenhouse-grown cannabis for as low as $200 per pound and are actively working to get their cost-of-goods-sold (COGS) closer to $100/lb. Their competitive advantage lay in location, climate, access to markets, infrastructure, and economies of scale.

Many small growers have commented about the inability to find buyers for their harvested crop. This exposes a key difference with larger growers, who commonly have contracts in place well before they start their clones. Their buyers value consistent quality above all else and have no use for a particularly good crop if it can’t be repeated harvest-after-harvest. As with beer and wine, most consumers want to know that they can buy the same product or label again and again with no variation. The market values reliable mediocrity over singular excellence.

So, what can be done to help California’s struggling small cannabis growers?

Well, the state could have limited cultivation ownership to no more than one-acre for the first five years, as many industry advocates believe Proposition 64 had intended.6 This would have prevented the consolidation of so many licenses into so-called “mega-grows”. Statewide there are 273 ownerships of more than one-acre, the largest of which encompasses over 58 acres of cultivation area. Limiting the size of ownerships while the industry was in its infancy could have created a somewhat more-level playing field, putting small growers at less of a competitive disadvantage. Unfortunately, that ship has sailed.

cannabis retailer in californiaAt the local level, cities and counties could increase the portion of the market available to licensed growers by allowing more retailers. Currently around 60% of California jurisdictions still don’t allow licensed retailers, effectively ceding a significant portion of the market to unlicensed and illicit businesses. HdL can provide fiscal analysis to ensure the number of retailers is matched to the size of the local market, improving access for consumers. We can also help review and revise local cannabis tax rates to ensure they are competitive with other jurisdictions while maximizing revenues for the city.  

California’s cannabis industry is being shaped by the same free-market forces that shape other industries, with the predictable result of concentrating market share into the hands of a few large companies. It is likely that independent small businesses will continue to struggle as they compete for some small percentage of the market. None of this is unique to the cannabis industry. It’s simply the reality of the free market. 

 

Sources

  1. Duncan McEwan, et al (January 2017) “Economic Impact Analysis of Medical Cannabis Cultivation Program Regulations” California Department of Food and Agriculture
  2. Cannabis Tax Reported Cultivation and Excise Revenue by Fiscal Year
  3. National Beer Sales & Production Data
  4. The WBM 50 Largest Wineries
  5. Department of Cannabis Control Large Cultivation Licenses and Conversions
  6. Growers Association Sues State Over Large-Scale Marijuana Farms in California

 

 

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