Although not as common as their non-integrated counterparts, there is a compelling case to be made for vertically integrated supply chains in the cannabis industry.
As consumer cannabis companies continue to compete amongst each other to capture market share, the businesses that have full control over the supply chain will be best positioned to take the industry by storm.
The cannabis industry is a sector where companies are constantly innovating. Whether it be in the form of new products, proprietary technology or relentless expansion, cannabis businesses are fiercely competing amongst each other for market share in their respective areas.
In doing so, most companies have chosen to focus on a specific area along the cannabis supply chain. Major cultivators for the past year have focused on growing their cultivation capacity, while other companies, such as cannabis biotech firms, have invested in expanding their research capabilities. While many companies have chosen to specialize, a number of vertically integrated “seed-to-consumer” cannabis business models are beginning to compete in the space.
Some industry experts argue that the future of the industry won’t lie amongst specialized companies. Instead, businesses that embrace vertically integrated strategies could stand the best chance of flourishing in the future Canadian marketplace. John Kagia from analysis firm New Frontier Data described this very same trend, saying “Brands which have been able to effectively identify specific consumer segments and tailor their branding and marketing strategies to reflect the priorities and preferences of those groups are best positioned to compete as the market matures.”
Vertical integration enables cannabis companies to maximize their efficiency, reliability, cost reductions and product quality in a way that sets them apart from the rest of the competition. While most companies focus on one area of the supply chain, vertically integrated seed-to-consumer businesses are able to control every aspect of their business model, avoiding the logistical nightmares that so often become a reality when dealing with multiple parties.
The idea of controlling multiple areas of the supply chain is a known concept in more mature industries. As a relatively new industry, the Canadian cannabis market has remained segmented across the supply chain. As such, fully integrated cannabis companies that own cultivation facilities, extraction labs, manufacturing centers and retail storefronts are a rarity in today’s environment.
The lack of vertical integration amongst these companies is understandable as adopting this approach comes with its own hurdles. For one, private companies are often strapped for cash, making the relevant acquisitions difficult to secure. Instead, it’s easier for companies to focus on scaling their strengths while pursuing a more specialized approach to business growth.
Companies with strong retail and branding presences are best positioned to become dominant in the years to come, while businesses that focus on a specific area could find themselves boxed into that market segment. For example, large cultivators such as Aurora Cannabis (TSX:ACB,NYSE:ACB) could find themselves confined to the cultivation sector, supplying cannabis to retail brands that control the downstream supply chain. In this sense, large cannabis companies are motivated to expand their operations across the supply chain into different product types. One of the best ways to make this process of product diversification as efficient as possible in terms of cost savings would be through vertical integration.
At the same time, some jurisdictions make vertical integration almost impossible. In provinces such as Quebec and Nova Scotia, province-run retail distribution systems force private companies to follow certain criteria while forbidding their own dedicated retail dispensaries from being opened.
The benefits of controlling the entire supply chain
Even with the hefty capital investments required, there are many powerful reasons why vertical integration is beneficial for a company. For one, managing all aspects of the supply chain gives a company the opportunity to maximize cost reductions and improve efficiency. This streamlining of the logistical process is impossible when dealing with third parties, which add their own costs and profit margins. Without middlemen, companies can cut costs in the long run, internalizing profit margins that otherwise would be passed along to third parties.
Aside from savings and convenience, vertical integration is perhaps the best way for a company to guarantee the quality of its product. Consumption-based industries in Canada find themselves having to comply with a variety of Health Canada stipulations where quality control is crucial.
Contaminated shipments or product batches could prove disastrous for both a company’s consumer reputation as well as its record with regulators. Health Canada has no qualms about revoking licenses for businesses, and once trust is destroyed with retail customers, it’s very difficult to build it back. When relying on third parties, there’s always the risk of potential contamination from their side of the operation. Through vertical integration, companies can monitor every aspect of product development, applying their quality standards universally without having to worry that a third party might not have standards equally as stringent as its own.
“To maintain the highest quality control, it is a business imperative that every step in the process be controlled, monitored and evaluated, especially during the rapid expansion into new distribution channels,” said Craig Goodwin, president of hemp-based health foods company Naturally Splendid Enterprises (TSXV:NSP) in an exclusive interview. “Vertical integration allows for quick reaction to market conditions, whether that is developing new products, servicing new clients or expanding distribution channels.”
In addition to quality control and expense reduction, there are other compelling advantages for vertical integration. One of these is that for vertically integrated companies it’s much easier to create economies of scale and expand rapidly. If a business relies on a third party for retailing, product development or any other service, it might not be possible to scale up as quickly due to potential constraints from other parties on the supply chain.
Current leaders in vertical integration
There are a few notable companies that are capitalizing on the vertically integrated seed-to-consumer model. Harvest Health & Recreation is a major example of this. The company has multiple separate vertically integrated operations across a variety of states, including Arizona, Ohio, Pennsylvania and Massachusetts. Around 60 percent of all products sold in Harvest’s retail dispensaries are produced by the company itself. For most cannabis companies, this is a very impressive figure that would be difficult to meet if Harvest didn’t emphasize a vertically integrated approach.
Another company that operates this way is Next Green Wave (CSE:NGW). Operating largely in California, the company boasts some of the top award-winning seeds and clones used in cultivation and it is able to produce new premium strains not seen before amongst consumers. The company has targeted California in order to gain access to an established and well-supported industry. While Canada’s cannabis market remains in its early stages, Next Green Wave has already secured a license for distribution in California, letting the company sell not only its own products but also the products of competing companies. The company’s foothold in California could give it an edge in North American cannabis as the legalization movement sweeps across the continent.
For a company that has chosen to focus on the quality of its product, Next Green Wave’s decision to operate its own processing and retail facilities guarantees full control over its end product, a critical step when building brand loyalty.
Over the coming years, cannabis as an industry will shift dramatically and companies that chose to pursue a vertically integrated strategy could be best positioned to stand apart from the competition. While there are some difficulties in pursuing this strategy, a seed-to-consumer business model is one of the surest ways to reap unparalleled advantages in logistics, pricing, quality control and branding.
This INNSpired article was written according to INN editorial standards to educate investors.
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