Prior to legalization, the illicit cannabis market generally followed a simple formula: grow plants and distribute dried flower. In today’s legal market, the proliferation of pre-rolls, tinctures, capsules, edibles, beverages, topicals, and more has created a diverse landscape aiming to bring in as many consumers as possible.
In reviewing 2,000+ pitches, Canopy Rivers has developed a view into how the cannabis value chain is evolving. In legal cannabis markets, we believe the most successful companies will specialize in one or two verticals of the cannabis value chain. In other words, they will focus on being horizontally integrated, instead of vertically integrated.
An already complex ecosystem becomes even more intricate as we dive into each vertical. For example, cultivation is essentially the indoor, greenhouse, or outdoor farming of the cannabis plant. It typically requires high capital expenditures and skilled farmers who can create barriers to entry with low-cost, high-quality products.
As we move a few steps forward in the value chain, to consumer products and accessories, some companies begin to look more like marketing-heavy organizations such as P&G, Nestle, or Unilever. Their brands become their most important assets, and support is built internally through large marketing and sales teams. These companies will then frequently outsource production, distribution, and logistics to get their products to market.
Today, many cannabis companies are tied up in managing the entire value chain. Vertical integration, in our view, should remain an option only for large companies, like Canopy Growth as an example, that have the resources, talent, IP, and capital to be successful across the value chain. In a sector with limited capital and limited talent, most companies are not likely to be able to effectively compete in cultivating, extracting, marketing, and retailing cannabis.
While the cannabis industry may be nascent, the idea of vertical integration is not. We can look at the emergence of internet businesses during the dot-com boom as an example of how vertical integration just didn’t work. Vertical integration for a start-up online pet food company, for example, needed to do the following themselves: product formulation and development, marketing, software development, payment processing, web design, inventory management, e-commerce, and data hosting. This often required enormous sums of capital and forced many early-stage companies to go public to get the funds needed to support their high burn rates.
The vertical integration model for internet businesses subsided as capital markets cooled on vertically integrated companies. Specialization took hold and the companies that emerged tended to focus on doing a few things very well. Looking back on our example, our pet food company could outsource to turnkey solutions such as Shopify, Amazon Web Services, and PayPal. These specialists simplified the value chain, enabling companies like our fictional pet food start-up to develop, market, and manage the inventory of its product.
To date, cannabis companies have vertically integrated primarily because regulations mandated it, as well as a lack of consistency in product and service quality in areas where vertical integration wasn’t required. We are now seeing regulations slowly loosen and specialized companies are consistently delivering quality products and services. As a result, the cannabis market is slowly shifting towards horizontal integration. PharmHouse and Village Farms are focused cultivators. Medipharm and Canapar are extractors with ambitions to be the best in that category. High Beauty and Dreamt are two brands focusing on one narrow area of the consumer products vertical. This hyper-focus may enable these companies to master their craft and scale without overstretching their resources.
We believe that the future of the cannabis market will be dictated by companies specializing in solving specific customer concerns. We see horizontal integration as the future of the cannabis industry, and we are watching it develop right in front of us.
This is not an offer to sell or a recommendation to trade in any securities. This information is provided as of the date hereof. This document contains data obtained from third parties that Canopy Rivers has not independently verified. This document also contains forward-looking information within the meaning of Canadian securities law, which is based on certain assumptions. While management believes these assumptions are reasonable based on information available as of the current date, they may prove to be incorrect. Many assumptions are based on factors outside of Canopy Rivers’ control and actual results may differ materially from current expectations. Forward-looking information involves risks, including, but not limited to, the risk factors set out in Canopy Rivers’ most recent Management’s Discussion and Analysis and Annual Information Form. You should not place undue reliance on forward-looking information. Except as required by applicable law, Canopy Rivers assumes no obligation to update or revise any forward-looking information to reflect new events or circumstances.
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