The Top 4 Challenges Facing California Cannabis Retailers in 2019
Just over one year after California made adult-use recreational marijuana legal, state and municipal agencies are still trying to figure out the nuances of the industry.
The first year was far from perfect for either retailers or regulators. The first six months of recreational sales acted as a transition period when cannabis products that did not meet California’s new manufacturing and packaging regulations could still be sold. Though there as a six-month lead up to this moment, many stores still had a shortage of compliant marijuana goods—in some stores, there was 60-75% fewer products after July 1.
For a variety of reasons, California’s cannabis market did not live up to the sky-high projections. Despite California being perceived to be a liberal bastion for cannabis rights and a state filled to the brim with smokers, the reality on the ground is more sobering: as of December 2018, less than 20% of cities in California—89 of 482—allow retail recreational cannabis stores to set up shop.
Retailers and advocacy groups are working to reverse this trend and make the California cannabis market as strong—and fair—as possible. Now that retailers and regulators will have a year’s worth of experience under their belt, they can begin to address the myriad issues.
Here are the most pressing concerns we see playing out for the rest of the year.
New Compliance Regulations Clash with Licensing Procedures
One of the most important and difficult parts of the legal cannabis market is ensuring the safety and authenticity of the supply chain. Since the black market is still a strong contender in the state (see below), regulators have been working to come up with a compliance solution that reassures consumers without pricing them out—and sending them back to the black market.
The original solution was track-and-trace, a statewide system that could record the inventory and movement of cannabis through the commercial supply chain. The system is being updated to METRC (Marijuana Enforcement Tracking Reporting Compliance), which tracks cannabis plants and products with RFID tags which add a cost of $0.25 to $0.45 per product. METRC compliance will soon be mandatory for all California cannabis companies.
However, the rollout is not as smooth as it could be, in large part because compliance is tied into the licensing process. As Marijuana Business Daily reports, only 14 companies were using the METRC system by Jan. 10, 2019 and only 31 California companies had been granted annual licenses. With thousands of companies waiting to be approved by the state, that means thousands of companies are operating outside of the METRC inventory tracking system.
Looking for California Cannabis Standard Operating Procedures? #sop Look no further! We just updated our SOP’s for the new regulations released in January 2019. Everything you need for a #calcannabis #license #METRC #compliance #seedtosale https://t.co/gRREg8Zhp8 pic.twitter.com/t6bshgzj6o
— Adilas420 (@adilas420) February 21, 2019
The result, according to Dr. Juli Crocket, compliance director at consultancy MMLG, is going to be a messy, two-tier system for cannabis compliance. It’s going to be a clunky start because you are going to have these annual licensees coming onto track-and-trace and undergoing the CCTT system and interfacing with paper systems for people who are still on a temporary license,” she said.
The transition period effectively creates an awkward scenario for retailers waiting for an annual license: METRC provides a better system for retailers and consumers than the paper-and-pencil system, but it places a high cost on the retailer during the transition. It also creates two different sets of inventory, one within the METRC system and a non-compliant set that retailers are using before receiving an annual license and transitioning to the METRC system.
The beginning of the year will be a challenge as regulators try to clear the backlog of annual license applications and retailers to navigate the transition over to the METRC system with minimal waste and supply issues.
Snuffing Out the Black Market
The legal cannabis market faces stiff competition from the black market—even though legalization was supposed to snuff it out. As the Los Angeles Times reports, the first year of adult recreational use sales paints a worrying picture for legal retailers:
- As much as 80% of the marijuana sold in California comes from the black market, according to New Frontier Data
- The black market brought in $3.7 billion, over four times that of the legal market
- The state’s Cannabis Advisory Committee found that “fragmented and uncoordinated” enforcement allowed the black market to flourish
- The Bureau of Cannabis Control (BCC) sent out over 2,800 cease-and-desist letters to illicit cannabis shops and business, while only enforcing action against five of those businesses
State regulators and retail shops face a monumental task. It is a delicate balancing act, as the New York Times details. One the one hand, the over-production of cannabis in the state is leading to illegal exportation to other states and driving down prices in California. The state produced over 15 million pounds of cannabis while only consuming 2.5 million pounds, driving down prices for regulated cannabis to 1/3 that of other regulated markets. Even still, consumers aren’t buying from licensed sellers, and it is increasingly difficult for small cannabis businesses to survive when the system privileges companies who can take advantage of economies of scale.
“California’s illicit pot market was valued at an estimated $3.7 billion last year, more than four times the size of the legal market” https://t.co/Fehq1CAzcR
— Eric Anderson (@hugeupside) February 20, 2019
With state licensing costs upwards of $70,000 and lots of expertise needed to navigate the state and municipal regulatory environment, the initial bar for illicit retailers to transition into the legal market is high and the regulatory requirements are necessarily never-ending.
There needs to be a concerted marketing effort to educate the public about the difference between regulated and black-market cannabis retail stores and, for now, the state will have to do more to crack down on black market retailers while providing further incentives for them to transition into the legal market. As Hezekiah Allen, the chairman of Emerald Grown, told the Los Angeles Times, “California must be very careful not to let enforcement become a tool that the haves use to further shut out the have-nots.” Consumer education is perhaps the best tool to meet those ends.
Shifting Regulatory Landscape
The first year of cannabis sales operated under a temporary set of rules, but the Bureau of Cannabis Control released its final set of regulations earlier this year. The change in rules is creating a challenging landscape for cannabis retailers to operate in. The rule changes will also surely be met with critiques and lawsuits from many directions.
One of the most contentious areas is the delivery of cannabis. Per the BCC’s final regulations, cannabis companies can now deliver cannabis, even to the (many) areas in the state that have banned cannabis sales. While this may help companies increase sales, it also has riled groups like the League of California Cities, who say the ruling overrides the right of local governments to ban nonmedical retail sales.
On top of the changes implemented in the final version of the BCC’s rules, the California Legislature is expected to a take-up dozens of cannabis-related laws this year.
Take, for example, the rules regarding advertising. The original rules of the Adult Use Marijuana Act restricted advertisements around minors in every form of advertising. However, the online rules created a loophole for online advertisers. Now, a new law, AB 3067, closed that loophole at the beginning of the year, adding further regulations for how cannabis companies market their goods on the internet and apps where people under the age of 21 might see the ads.
On top of changes at the state level, retailers also have to contend with changes in the laws and licensing procedures at the city level. Los Angeles, for example, is currently undergoing a back-and-forth over Phase 3 licensing. As Canna Law reports, the city’s Department of Cannabis Regulation proposed “total reform for Phase 3 licensing in the face of multiple regulatory issues caused by undue concentration, the promotion of social equity businesses, and the overall economic interests of various stakeholders who are waiting for Phase 3 to open.”
Phase 1 and Phase 2 took longer than expected, and the Phase 3 rollout is expected to take even longer. The effect, as Canna Law notes, is that “the current proposed licensing process potentially harms everyone, including social equity applicants who have either already made the investment in the unsettled program or that don’t have the resources to invest ahead of time to their detriment.” While some form of change is going to happen, the slow back-and-forth disproportionately affects small businesses and social equity applicants.
In large part, the difficulties stem from the high amount of authority given to the cities to determine cannabis regulations. As 2019 progresses, retailers have to hope that the regulatory landscape starts to settle down.
Balancing Legal Hemp and Marijuana
In 2018, two laws changed the way people view hemp as a viable cannabis business. First, there was State Bill 1409, which removed many of the restrictions on who could grow industrial hemp and how it could be manufactured. In light of how popular hemp-derived CBD oil has become, and the fact that the legalization of recreational marijuana expressly ignored industrial hemp regulations, the bill made a lot of sense at the time.
Then, in December, President Trump signed the 2018 Farm Bill, which legalized industrial hemp cultivation throughout the U.S. and removed hemp from its Schedule I designation. However, despite both state and federal governments legalizing hemp cultivation, both are cracking down on the CBD market. A few days after the passage of the Farm Bill, the FDA released a note that struck down a lot of the excitement in the CBD market. And, in California, Los Angeles County Department of Public Health’s Environmental Health Division effectively banned the use of hemp-derived CBD in food, with enforcement actions beginning July 1, 2019.
— Andre F Bourque ♕ (@SocialMktgFella) February 24, 2019
That counties and cities are coming for hemp-derived CBD products is somewhat of a surprise in California, since it is a non-psychoactive chemical and is so popular already. As the Los Angeles Times reports, CBD from industrial hemp is a legal gray area but a huge money maker for all sorts of businesses, from coffee shops to food markets.
While the retail market for hemp-derived products remains partly unresolved, one issue with hemp that could affect retail may crop up earlier in the supply chain. After the passage of the Farm Bill, agricultural groups are encouraging central California farmers to switch over to industrial hemp. This year will likely be a big year for growing hemp in the state.
However, growing hemp and marijuana in the same area can negatively affect the purity of outdoor marijuana strains. As Oregon is finding out, growing hemp and marijuana in the same region can lead to cross-pollination, changing the phenotypical makeup of carefully cultivated marijuana crops. Pollinated marijuana can, for example, cause THC levels to drop and seeds to develop. As a result, many marijuana growers—since they take up less acreage, are moving indoors instead. It remains to be seen if California will face the same issue.
The retail market in California is complex, but despite the hurdles, the future remains bright. As the regulations and licensing system get figured out, the black market should start to diminish. And, when federal legalization happens, it will curb the black market even further, strengthening the legal marketplace.
Look to Verdantis Advisors for all of your investment and compliance questions. Our years of experience can help you navigate the ever-changing landscape in California. Contact us today to see how we can help your business.