Legal And Illicit Weed And The Economics Of Cannabis
Editors’ Note: This is the transcript version of the podcast we posted last Wednesday. Please note that due to time and audio constraints, transcription may not be perfect. We encourage you to listen to the podcast embedded below, if you need any clarification. Enjoy!
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Rena Sherbill: Hi again, everybody. Welcome back to the show. And now for something a little bit different. Today I’m excited to bring you the authors of a book that is coming out June 14. You can pre-order it of course on Amazon and other booksellers, book purveyors. It’s called Can Legal Weed Win?: The Blunt Realities of Cannabis Economics.
Today we have Dr. Robin Goldstein and Professor Daniel Sumner, the authors of the book. They are economists. Dr. Goldstein gets into coming from the alcohol sector. He’s also the author of a book called The Wine Trials. They both have a litany of distinguished experience in the economics world, in the academic world. It’s really interesting talk today about the legal cannabis world, the illicit cannabis world, which we’ve been talking about for a few weeks, a few years perhaps, on the podcast. Will the illicit market curb, will it slow? Will it diminish? Will the legislators get it right? Are legislators to be believed in any way shape or form?
A really informed smart conversation today about the broader pictures of legalization and what that means for companies, what that means for bigger companies, smaller companies also get into the social justice aspect of it in terms of people that are locked up, and the all caps INSANITY of that, great conversation. I hope you learn from it as much as I did.
So welcome to The Cannabis Investing Podcast. Really happy to have both of you on the show. Thank you both for joining us. Thanks for coming on.
Daniel Sumner: Thank you.
Robin Goldstein: Thank you, Rena.
RS: Yeah, it’s great to have both of you. So the book won’t yet be out by the time this interview airs. But it will be out a couple of weeks from now. The title of the book, I mentioned it in the intro is Can Legal Weed Win? Robin, I guess let’s start with you. Do you want to give us kind of — I’d love to hear first before we get into the book, kind of where each of you is coming from and what kind of was the catalyst to make you want to write this book specifically?
RG: Well, I first became an economist because I was interested in food, wine and beer. So I was mostly a food wine and beer economist. Actually wine was kind of my number one specialty, before we got into cannabis. There are a lot of similarities between the alcohol market and the cannabis market in terms of the way they’re regulated, and kind of these leisure — these goods that people associate with leisure and having fun and relaxing and so forth.
We started working with the cannabis economics more intensely when we started working with the California — then called the California Bureau of Cannabis Control, which is now the Department of Cannabis Control. Dan and I had the opportunity to do some analysis of costs and benefits and make some predictions about the impacts of regulations they were considering. So as they were going through the process of drawing up regulations, we were doing some work on that and learned a lot in the process. Learned a lot of things that surprised us, learned more about cannabis economics than we ever thought we would I think so. I’ll let Dan added a couple of words there.
DS: Well, I’ll just say this. About the time Robin was born, I wrote a paper on cannabis production economics as an agricultural topic. It was a total failure. And I abandoned cannabis economics until Robin and I started, partly because nobody would give me any data, surprise, surprise. We are talking a long, long time ago. And friends of mine at the time who I know were producing it said hell no, we’re not going to tell you a word. We don’t trust you Sumner.
Well, things changed. And I’ll tell you what really got me involved in cannabis regulatory economics, after having worked on cigarettes as well as beer and wine. I was on a faculty in North Carolina for a while where tobacco was a big deal. And I wrote about tobacco smuggling as cigarette smuggling which was an issue. But what really got me was the lady who was known five or six years ago as the cannabis czar of California, Lori Ajax, when she called me up and said we’d like you to work on this. We know Robin’s involved and we’d like you both to be helping us with regulations.
I said no, no, no, get a consulting firm. You don’t need us. And she said, no, we would like to work with somebody who can help us try to understand what our regulations might actually do, and maybe even have a shot at improving them. And for an economist that was — I was a sucker for that. She had me. And so we agreed to work with the state bureaucracy.
Now she was also straightforward. She said, we only have a certain amount of limited things we can do. It’s a political issue in California, the proposition then passed and their arms were tied frankly. So their hands were tied about how much they could do as an agency. But we’ve continued to work with them. They’ve asked us to help them on licensing regulations, licensing fees, things like that. So that’s partly where we’re coming from.
And then this book goes far beyond that. But it does start with a dirt — I mean, it’s in that sense a purely agricultural topic. And then all the way through retailing, which is the way Robert and I both think about food and wine and everything else in economics.
RS: What would you say coming from an economic — from a — the economist perspective what would you say is your number one goal, between starting this endeavor and where you are now? Do you feel like it’s the same goal? And kind of what was that?
DS: Let me just say very quickly. The goal was the same from my point of view, help people who really care about it, real people, not our academic colleagues. Them too, but to help real people understand what’s going on in this industry. And with this commodity, and with the product, and it’s the economic surrounding it, which is of course, what investors need to know, and what everybody needs to know.
What Rob and I speculate, but we’re not particularly good at predicting politics. So if somebody says, oh, how is this Senator going to vote on that bill? Answer is, I don’t know. I don’t have a clue. I don’t even know –.
RS: I don’t think that Senator knows.
DS: In fact, lots of economists work on that. And I think it’s mostly BS frankly. But there’s nothing wrong with BS. It’s fun. But what we what we try to focus on is how do the economics add up, and what doesn’t seem to add up. And of course, as we know, in lots of industries there — everybody’s got an angle. And in a sense, we don’t have a dog in this fight. So in that sense, we can be an objective observer who’s trying to understand and help other people understand the economics. And that’s been the goal all along.
RG: I think another goal that then I had with Can Legal Weed Win, is to make it fun and accessible, and just a fun, easy read. If you know, a lot of economics we want it to be fun and interesting. And you come away with some things you didn’t know. If you know almost no economics, or if you’re a freshman, taking your first economics class, we want you to be drawn in by the — I mean, we think this is a pretty fun little corner of economics and with a lot of unique things about it, the competition between legal and illegal.
And one thing people see the book title Can Legal Weed Win, they say what? Some people say, how could it win? It gets legalized, and then weed becomes legal, right? And so we want to question people’s assumptions and when they finish our book, we want them to come up with, oh, well, actually legal weed could lose to illegal weed, if it’s not implemented, right, if the regulatory barriers or taxes or are set up in such a way that illegal weed remains the majority — remains the dominant segment of the market, and legal weed is just a smaller segment.
And that’s what’s happened in some states, what’s happening now. And we in the book, we also offer some suggestions and comments, and what types of policies or things that could be done to help legal weed win?
RS: Yeah, I think that’s one of the reasons why I was interested in talking to you and hearing both of your backgrounds and kind of what you’re looking to accomplish. I mean, I spend so much of my time talking to people who are bullish full stop on the legal industry. And that’s what’s happening.
Especially from an investing perspective, obviously that’s kind of the game is the legal side of things. But I am interested in talking to people that as you said, don’t have a dog in the fight and are coming from a neutral perspective, and what is it that they can tell us and teach us especially from the perspective you’re coming from. Like, what do we have to realize or kind of admit to ourselves or glean from the evidence that is I think right in front of our faces in terms of the illicit market’s success at remaining powerful even despite all these regulations that are that are unfolding before us.
So I guess, how would you describe where we’re at today for the investor, for the consumer, for the person looking at the industry wondering kind of how to play it, what they should be looking at?
DS: Well, let me say very — let me just start very quickly, if you don’t mind, Robin, to say, when we first looked at this, the proposition was — and I think it’s still true in many cases. The proposition for the consumer and the producer, both of legal weed, from the consumer’s point of view, many consumers have been consuming for a long time. Or maybe they’re 18 years old, and just went off to college and thinking about it. In most places, they don’t have access to legal weed.
So — and they know a guy who knows a guy or their brother-in-law does or something. And — or they’re a mature consumers, in say in California consuming legal, medicinal, almost legal medicinal weed for 20 years from an unregulated sector. And they say, oh, great, this is wonderful, I can now not buy from the guy I’ve been buying from for 20 years. I can go down to the mall and have the opportunity to pay twice as much. And I’m being reasonably happy with the transactions I’ve been doing.
From the sales point of view, somebody who’s got a business, they have a supplier, somebody’s growing it somewhere. They don’t necessarily know a whole lot about it. Maybe they do, maybe they don’t. But the grower and the wholesaler, and the retailer, in the illegal side, say, gee, I can now go to my customers, and say, I’ve decided to go legal. And so I can’t deal with you anymore, because you have — or maybe you haven’t got a license yet. So I can’t deal with you. And instead, I’m going to deal with somebody else who’s going to have customers, who they’ve never dealt with before, who have the opportunity to pay twice as much.
And in order to do that, I’m going to go through a 1.5 year wait to get a license and pay a bunch of taxes and fees, and being a business. I frankly don’t know how to be legal. I don’t know what pesticides I’m supposed to use. What do you mean, I have to have a Porta Potti in my field. What are these rules you’re telling me?
So I think it really is obviously a challenge when you think of it that way. And it shouldn’t surprise us that in most of the country where weed is legal, we can put that in quotes, maybe 20%, 25%, 30% of the market has decided to go that route. And once you say that — and then you say now what’s the step to take the other — to go to 40% and 50% and 60% and 80% legal? It’s not obvious. It can happen. But it’s not obvious. And I think every investor are realistic, simply say that themselves, whether they’re investing in Canada, where they’ve already got their federal legalization, or whether they’re investing in New York or California, or an emerging Virginia market. They ought to say to themselves, this is — it’s not obvious that it’s going to be easy.
RG: Yeah, just to pick up on that point, investors — savvy investors in cannabis are certainly paying a lot of attention to the differences between states. I mean, that’s like rule number one. Every state’s regulated totally differently. And when I say states are really different in terms of opportunities, I don’t just mean like saturation. And I don’t just mean tax rates. I mean, things like timelines. For example, in some states, it takes three or four years routinely for some types of businesses to even get a license. And so that from an investment standpoint, that can be fatal.
I mean, if you’re burning cash, and you have — and you’re paying rent, and there’s an unknown waiting period of years for your license to come through, you better be well capitalized. And that’s something that investors need to be thinking about all the time looking at the experience of other businesses, in that, in whatever segment you’re getting into.
Looking at saturation of different segments it’s hard to do because no one knows exactly what the market is able to bear, in terms of the number of cultivators or the total cultivation space. But if you see a state where there’s 10 million square feet of cultivation area already licensed and do some back of the envelope calculations and that state needs 500,000 square feet of cultivation area to cover the entire market currently, then that might be a warning sign, maybe cultivation is not the right segment in that state.
Another point, I think, really important point that investors I think are not necessarily thinking enough about is what happens when federal, legalization or interstate trade become part of the game. And so — and no one really knows what shape that’s going to take. It could be anything from a very light system of just cannabis gets descheduled as a narcotic Federally and states are just allowed to go on operating as they are, but with less kind of obstruction, with problems with banking and so forth. Or it could or it could be a heavy regime of federal taxation and licensing and other regulations.
But whatever form that takes, it’s — if you have interstate trade, then you have to be really careful about what state you’re going into, and why. Because some states have cannabis rules locally where it’s a lot more expensive to produce. Some states, electricity and water and land are more expensive. And so when you’re competing with cheaper weed from out of state, in a national market, then that can be a threat we say in the book, not just a benefit to your business, in whatever state you’re in.
RS: So let me ask you a question about the interstate commerce and the Federal legalization. When I first started this podcast, which is a couple years ago, I was under the impression that you know, the descheduling of cannabis and the federal legalization was maybe sooner than it’s come. And also thinking, oh, when that happens, interstate commerce is going to happen because it’s legal. But then as you learn how things work and understand how protracted the process is. A, legalization probably isn’t happening in the next couple of years? And even if it did, or when it does, the interstate commerce isn’t okay, the second, it’s legal, interstate commerce opens up.
So A, as economists, how do you see that? And what makes the most sense to you if you could draw it up yourselves? And B, how do you think about that, as these states are going online, how do you think about, something we’ve been talking about on the show a bit is the kind of de-facto interstate commerce that’s going to happen with these neighboring states, as more and more go online? How do you think that starts looking?
DS: I’m going to leave the legal details to Robin, who’s not only economists but also is a lawyer. But because I haven’t ever had a course in constitutional law. But I will tell you that, I mean, where we start off, as we say, weed is kale. What the heck, weed is watermelons, except it’s more like kale in the sense that — it’s more like dried parsley in the sense that transport costs are about zero, compared to the value of the crop.
You can put a million dollars worth of cannabis in the back of a minivan and still have plenty of room for all your kids. So its transport cost is zero. So there’s none of those barriers. This is not like shipping soybeans, or milk or something that’s bulky and cheap relative to the transport costs.
But secondly, if you thought of cannabis at scale, you don’t put any federal regulations on. You just leave that all to the state and local. And one of the concerns is legislators and federal regulators sort of can’t help themselves. They say, wow, this needs us. And then you end up with — say you’re in Oklahoma, where there have been fairly loose about licensing rules. And now you have a whole bunch more rules. Or you’re like California where you haven’t been loose about licensing rules, and there are plenty of rules. And there’s rules in every county that differ in every county. And now you lay a federally complicated system on top of that, and you just doubled every complication.
Specifically with respect to interstate commerce, let me say this. In general, interstate commerce, just comes with legalization unless somebody as I understand it, the federal government is the only buddy, only entity that gets to regulate interstate commerce unless — and then you get some lessons, and in fact, there’s a Supreme Court case, going to happen next term on something I’ve worked a lot on, having to do with pork.
So we don’t just do cannabis. Robert and I both did a lot of work with the pork industry and also with the State of California, because State of California has a rule that says starting January of this year, I couldn’t eat a pork chop unless the mother of the pig that turned into that pork chop was treated in the way that California regulators say it should be. Well, that sounds like it violates interstate trade, but it, California thinks they have some reasons why they can restrict that.
But generally, the federal government supports or allows interstate trade. It’s not normally the organization that says we don’t like free trade. And and so it’s hard to picture that. I could see some states saying we’re still dry. But and where Rodman’s point is, is it’s hard looking at data now we pretty much know who’s good at growing lettuce. We don’t know who’s good at growing cannabis under different regulatory approaches.
RG: Yeah. To pick up on the pork point, so you could — you have a state like Massachusetts, where you have pretty rigorous or involved, let’s say, regulations. For example, testing in Massachusetts, you have to test every 10 –you have to take a sample from every 10 pounds of flour. In California, you have to take one sample for every 50 pounds of flour, test it for all sorts of pesticides. Some states don’t have any pesticide testing requirements.
So Massachusetts could say, we outlaw, under state law, we outlaw the sale of any cannabis within Massachusetts that doesn’t meet Massachusetts safety requirements, meaning having to test every 10 pounds. And then — and if that law were to be upheld, were to withstand commerce close scrutiny, as Dan said, and it’s not clear it would, but if that law were upheld, then you’d have, if you’re from Wisconsin, and you’re producing cheap weed there, and you want to ship it to Massachusetts, you’d have to pay extra for — to meet Massachusetts standards and ship it into Massachusetts.
And so that’s a sort of protectionist tactic, if you will for Massachusetts producers to stay in business and compete successfully against cheaper stuff from other states. The reasons it’s more expensive in Massachusetts, because we have higher safety standards. And whoever ships it in needs to meet those standards too. But there’s nothing they can do about the cheaper electricity and water in Saskatchewan, if it’s coming from Canada, in Massachusetts. So it’s always going to be tough to compete on input cost. It’s always going to be a competitive problem for states where things are expensive.
RS: And so how do you see it growing, kind of looking at this patchwork of states that we have, the growing number, how do you see a growing and developing?
RG: I think we’re going to see — continue to see the trend of more states moving toward medical, and then we see this progression of medical and then recreational. Some states might — as things move along, might start skipping the medical stage. It’s interesting actually, to me. And it’s politics, which I don’t know much about. But it’s interesting that you’re still seeing this two stage process in many states.
But even though in the states that have moved from medical to recreational you’re often seeing the medical market kind of just disintegrating or just merging into the recreational, as in California. So that’s one kind of open question whether states will start skipping the medical stage or not. Dan, go ahead.
DS: Robin, I think started at exactly the right spot, which is the spread around the country doesn’t seem like it’s slowing down or going to stop. Maybe, if you remember, Oklahoma was a dry state into the 20th century, well into the 20th century. When I moved to North Carolina, a long time ago, they still had all kinds of elaborate rules about alcohol. But finally those faded away.
So one can concede, legalization within states is spreading. The challenge every one of these places is if everybody thinks it’s a cash cow, then it — or needs to meet every current regular, fashionable regulation, since it’s newly regulated, you say, and every one of these regulations are for a good cause. Let’s have equity among the owners. So let’s create opportunities for people that haven’t had other opportunities. Gee, let’s make sure that it’s grown in a way that’s environmentally pure.
I mean, cannabis, in many places is purer than organic parsley. You can’t grow it outside, because your neighbor three miles away might have used some material that’s perfectly legal to use on watermelons but you couldn’t use it on cannabis, for example. So there are all these problems. Let’s make sure that we use green electricity only for cannabis because we have an opportunity to. Well, fine. All of those are great things. We’re all for them. Not a bad thing among them.
But they’re not free, which — and then you have this other industry you compete with. I think regulators with big hearts have to realize that they’re talking about an industry that really is competing with people that aren’t playing by the rules. Now correctly, many regulators say, oh, we hear that all the time, or you can’t regulate my industry because we compete with Mexico or Canada or somebody that doesn’t follow the rules. So therefore we’re going to regulate anyway.
I think here’s a case where you can regulate all you want, but if nobody actually is legal, because they all had to stay illegal, you haven’t helped your industry. So that’s the other thing for investors to think about, how friendly is the broader regulatory scheme in this industry? And that could be a key to internet interstate competition.
And Robin says, of course, Massachusetts can say the weed doesn’t meet your standards. There’s a question and this California’s — the Supreme Court case on pork may tell us something about where the court is on this. Can you have rules where California says we really care how pigs, how mother pigs are treated in Winnipeg, Canada, because that’s where a lot of the mother pigs are. Does California have the authority to do that, and block trade on that basis? We’ll find out.
RS: I mean, it seems right now that the regulatory process for cannabis is quite unfriendly, and states are not necessarily willing or wanting to help the other state out or help — what is — as that develops, do you think that’s dependent on the bigger players, and the lobbying and the politics? And is there hope, room for any of the smaller operators to kind of get in there, aside from just being acquired by one of the bigger players?
RG: Smaller operators, I would say — I’ll take the second part of your question first. The smaller operators who succeed are obviously in general, as a rule, smaller operators are selling at higher prices, because they are running smaller operations that don’t have as much economies of scale and buying power and so forth. So they — the ones that will succeed, the minority, I’ll say that will succeed will be craft, so called craft brands. The ones who are able to make a name for themselves sell at a premium price point, by communicating extra value to consumers in some way.
That’s a tough game. It’s a small — it’s a small minority of the market share. And it’s a lot of folks competing in that little segment. I think in cannabis, when I think about what will be the successful strategies, and we talked about this in the book, what will actually be the successful strategy, if you are a smaller grower, let’s say or manufacturer and want to compete at a higher price point, I think one of the keys will be regional identity.
And that’s a key thing in wine. With wine, Napa Valley is famous for making some of the best wine in the world. And so people are willing to pay a premium to know that their wine comes from Napa Valley. Cannabis appellations of origin, denominations of origin if they’re formalized, or just regions of origin will have to be marketed. And I think that as a group — you could have a group of producers from Humboldt County saying Humboldt County weed is the best. And kind of, they come up together, and they’re able to sell in other markets at a premium.
I think that’ll be a better strategy for outdoor grown and indoor grown. There’s an interesting phenomenon where right now, indoor grown is associated with being the highest quality or highest potency anyway. And most expensive weed, the most expensive stuff is generally indoor grown. And that’s partly because of technology that you can only use indoors, but it also has a lot to do with the fact that historically outdoor grown weed has been lower potency, because part of their goal has been to keep it away from satellites and keep off the radar of the sheriffs, local sheriffs and the Fed. And so you have shade, you have shaded areas where they’re not getting as much sunlight, so the potency isn’t as high. And there’s just been this kind of informal thing that’s evolved where the lower potency stuffs out there. I think you can see that change in the future. There’s no reason you can’t grow really high potency, really high, whatever quality means, really high quality weed outdoors.
And I think that if you’re trying to market your denomination of origin or your — what’s special about your little region, it’s — climate’s one of the big things that differs between regions like with wine. Beer which is made indoors, they don’t talk as much about what — they don’t talk much about what the climate is of this beer. So that’s a point of differentiation where states like California that have wonderful outdoor climates for growing weed that could help them survive the competition on the premium segment.
DS: I disagree. Rena, one of the one of the interesting things about this area is that there is so much uncertainty. So I’m going to disagree fundamentally with Rob. And let me bounce it off you this way. And this is something he and I have talked about. I see the growing of cannabis to be a typical agricultural industry. How big are corn farmers? There’s a half a million of them.
Today, any commercial corn farm will grow millions of dollars worth of corn, any commercial weed farm will grow millions of dollars worth of weed, just like walnuts, just like kale, just like almonds. There’s hundreds and hundreds and hundreds of growers. And they grow commercial generic product that goes into — same with tobacco. They grow commercial generic product that goes into a commercial generic manufacturer of good vape pens, whatever. And I don’t see any reason that wouldn’t be true for cannabis.
The cigarette companies don’t vertically integrate down into growing tobacco. Beer companies don’t vertical — they’re not the major hops growers or the major barley growers in the world. There’s a bunch of people supplying those inputs. Now Robin may be exactly right about branding. And he may be — and that doesn’t mean of course that the manufacturing is big companies. The manufacturing can be done by lots of moderate-sized companies that can afford a few million dollars’ worth of equipment.
Branding, I’ll leave that to Rob and he may be exactly right. There may be some brands that take over, the Marlboro of cannabis. I’m not so sure, you go into the beer market. There are a few major companies that they end up having dozens and dozens of brands each. So it’s — I’m not sure that we have the scale economies in cannabis that we have in some of these others. Now 50 years from now, there may be the CVS of cannabis stores that’s got every corner and every town in America has the same branded store, like a Kroger’s or a Safeway or whatever your local supermarkets are. That could happen, but I’m not so sure. We’ll see scale.
Now that doesn’t mean that mom and pop, that want to grow $25,000 worth of cannabis is going to die. They may be the market that Robin’s talking about, where they sell at the local farmers market, or something like that.
RG: Yeah, or sell to manufacturers. I mean, I’m talking about the growing segment, right? I’m talking about how kind of small growers survive. And I think it’s by promoting their region of origin, like wine, like with wine.
DS: Well, almost all the wine Robin is grown by very small operators. And it’s not regional in origin. I’m talking about — I’m talking about wine grown in Fresno.
RG: Yeah.
DS: It’s grown by small growers, and it sells to big wineries.
RG: Well, that’s still sold as California wine and California as a state still commands a premium over maybe Washington.
DS: No, no. It’s bagged in a box wine. And I can tell you — this is the wine that Robin doesn’t buy, see. So he doesn’t know what the rest of us do. So you have a bag in a box. And what it says is this is a product of USA or Argentina or Italy. So I really don’t think for generic product, most people aren’t going to care what the origin is.
RG: Yeah, that’s 90% of the market. I’m talking about the other 10%. Like with wine.
DS: The high end of the market.
RG: The high end of the market, that’s all I’m talking about. I’m not talking about the generic stuff like the boxed wine.
DS: Yeah.
RG: And my claim is that for the 10%, let’s say at the high end, that regional marketing, if regional marketing emerges as a successful strategy, then cannabis will look more like wine. If it doesn’t, it will look more like beer or tobacco, which is an extreme case. With tobacco, you really have almost no craft or premium brands.
There’s just a few — I mean, in big cities, you see a few expensive cigarettes, but in most of the world, there’s a few brands competing that are made by a small number of companies and they’re all kind of gigantic generic and cheap compared to something like wine where you have — where you do have a 10% that’s really differentiated by region of origin.
RS: And is that coming from — because the other thing about what cannabis people are buying is — has to do with what gets in the dispensaries, has to do with the companies that are mostly at this point vertically integrated, because of the regulations in different states. How does that keep developing? And how does a brand kind of get that awareness, when not everyone — when I would say most people don’t know, you know which company or brand is coming from, or if they can get the brand in a different state or what have you.
DS: Those are the — consumer product branding, of course is as much art as science or a lot more art than science. So which celebrity do you get that allows them to put their picture on your brand? I think we’re probably over the era where my generation of cannabis celebrities still have much cache, maybe a little bit. And we may be over the general —
RG: Cheech and Chong.
DS: Yeah, yeah. There you go. And we may be getting nearer to the end of the generation where it’s sort of rap music. People who used to make a style out of being illegal. And we may — maybe this cannabis is endorsed by John Kerry, this is this —
RG: Some Kerry weed smoke the Kerry weed.
DS: There you go. So you take some absolutely the straightest arrow you can think of and say, yeah, they’re endorsing this as recreational cannabis. Just like you can have somebody endorse a wine or a beer as being absolutely mainstream product.
RS: That’s a segment that hasn’t been optimized yet.
DS: John Boehner.
RS: Boehner’s Blunts.
DS: Yeah. So we’re actually playing this game, it has to be Elon Musk weed. There you go. So if you had Elon weed, you’d be selling a lot right away. Headphones.
RG: What do you think McConnell weed would smoke like? Would that’d be some dank stuff?
RS: I was going to go in the opposite direction. I’m thinking it’s not the primo — not the 10% of the market. But maybe, who knows? If he’s going to get into it, maybe it’s the best. I don’t know.
RG: Watch what you tweet after you smoke it? Yeah, I mean, I think this points to a legitimate point, though, about how to compete. And I think it’s really hard. One of the reasons, it’s really hard to build up a brand, whether it’s a state brand, or a national brand, is you’re competing against Snoop Dogg and Matt Damon and whoever else is in the industry with just unlimited resources. And already, people who are already famous and selling someone’s name, famous name is relatively easy in the branding world compared to getting some brand in people’s minds that they’ve never heard of before.
And that’s why I keep coming back to this point about the importance of regional marketing. Because if a bunch of small producers in some region that gets — that collectively have a name, that region serves as the brand rather than the individual producers, and then they can come up together without having to individually spend so much marketing money or have the power to compete with these huge players. That’s not to say that it’s easy to do that either, and it’s not — it could take the form of organized or completely disorganized, kind of group of people doing this, each independently promoting their region and the region getting known.
Or there — or you can see things like regional associations arising where they do some collective bargaining. That has kind of a checkered history of whether it works or not. But yeah.
DS: Those are challenges. In terms of investors thinking about this market, the things that Robin and I are talking about are things you can learn from looking at other markets, whether it’s pasta or wine or cigarettes or whatever. And my favorite guy in the tomato business, this is processing tomatoes, processing stuff. Everybody was looking for a niche. And he said, I think I’ll just smash tomatoes harder and faster than everybody else. And he’s the guy that won in the generic business.
It wasn’t a — it’s not a big firm, it’s not a huge industry. But he’s the guy that’s able to compete with the Chinese or whoever, because that’s global competition. So there is room for people in the wine business. It would be somebody like the Gallo Family. They’re not a big corporation. They’re just a family. But they’re the biggest wine producer in the world, because essentially they’re buying a bunch of cheap grapes and smashing them really hard, really fast,
RS: I was going to ask like, as we’re talking about this regional development and these regional brands, how do you think that plays into this kind of like right now we’re looking at the California market, and there’s kind of so many issues between illicit and licit. And then we look at across the country with New York and New Jersey going online and Pennsylvania and Massachusetts and all these kind of neighboring states.
How do you see that regionality if — I know that’s not a word, but how do you see that kind of more specific locations developing across the states?
RG: I mean, one, one very simple trend we see when we look at our data is that there’s a timeline where when any state first legalizes the weed gets — it starts out more expensive and gets cheaper over time. So the cheapest weed in America right now, as we see is in Colorado and Washington where they were the first to legalize. And they legalized 10 years ago by ballot question. They’ve had legal — they’ve had legal licensed operators in the recreational weed business for eight years.
And so there’s just some growing pains, and there’s people getting up to scale. And then there’s regulations that are kind of unworkable at first and states revise, revise, revise and realize problems that are coming up and make some effort to fix them, at least we hope. And you see that in some cases. And so there’s just a level of maturity that’s kind of across the board. But you look at a State like New York, and which had a — is coming from I think an important question is what medical — if they’re going from medical to recreational, what medical system are they coming from?
In California, you had a medical system before that was basically unregulated by the state. But you had thousands and thousands of dispensaries already all over the state in almost every city in town and thousands of growers. In New York State, you have only a small handful of licensed medicinal sellers that are regulated, like pharmacies were heavily regulated and had to — get a special permit from the state. So you have this totally different system of like cronyism and it was very political who got in before.
It’s not clear in New York, whether how much that’ll have to do with who succeeds in the more — in a more open recreational market. But states that are — I think, as a general rule states that are very early on, they might look like the best opportunities for some investors, who are like, oh, we’re getting an early. But that comes with a lot more uncertainty. It’s the biggest uncertainty of all this is kind of timeline. How long will it take for the system to really roll out and become viable?
You have Vermont. There was legalization that happened four years ago, and last time I checked, they still didn’t have a single store open. And whereas Oklahoma you had — what took Vermont four years took Oklahoma about nine hours. You had the first stores opening the next morning after the ballot question passed — or after the — sorry, after the legislative act passed. And so those are some of the really important differences to pay attention to. I think you can’t make broad generalizations about regions. It tends to be more expensive and more regulated in the Northeast, let’s say.
But I think you just have to really treat each state as a totally individual beast with all its own problems and risks. And then when you do see a federal legalization coming into play, then you might see more convergence down the road between states. People start looking at federal rules and kind of integrating state rules with those possibly as time goes on. But that’s — we don’t know how far away that is still.
RS: Do you feel like there’s players that are doing it specifically right? Aside from kind of the regional branding, do you feel like there’s operators that understand kind of the machinations better than others? Does it depend on size? Does it — do you feel like either of you have a sense of something that you can look at in terms of what business is able to kind of scale that better than others?
DS: You know, Rena, I think the important thing is for the business to understand themselves. So if you say look, we’re in it for the long haul. It’s going to take years and millions of dollars before we start turning a profit. And that’s okay. There are the headlines yesterday about the electric truck company that has now lost 85% of its value from when it went public and you say — my guess is the people on the inside of that company looked at the valuations, how far their stock went up and said, what are these people thinking? That’s my guess.
We know we have a really long road in front of us. And of course, we’ve had supply problems, getting inputs and all that stuff. And a slowdown in certain regulatory change or federal subsidies there. And the same thing’s true in cannabis. I’ve heard people say, oh, great, you got in early. And somebody responding to that says, well we got in at the right time for us, which isn’t necessarily first. And sometimes being very early is great, depending on whether you can wait. But you could get in very early, and find yourself out of the industry three years later about the time somebody else gets in. That may turn out to be the right time.
And I don’t think any of us — there’s no formula for saying what’s the right time to get in. It depends on the company, and the situation. And you could look at Vermont and the long list of rules they were going to have before you could open a store, and say this is going to be a while. And it’s not a very big market to start with.
You could look at New York, which Robin has done and say, it turns out last time around, it was not what you know, but who you know, and can you manipulate the local ordinance to suit your company? And so you invest in politicians. And then in some markets, that’s the right you know, that’s the reasonable business strategy, even if we wish it wasn’t.
RG: Yeah, I agree with Dan. I think for investors, an important thing to keep in mind is there’s such a thing as too early. It’s the right time. It’s not getting in as soon as possibly in states and there’s things you don’t know that create kind of untenable risks, in some cases, that you want to invest a lot of money before you see how it’s going to roll out.
RS: So looking at the alcohol industry, I mean, there’s so many comparisons to the cannabis industry developing a lot like the alcohol industry, the beer and wine industry. Do you see it, kind of setting itself up like that, A? I guess, kind of how do you see it setting itself up? And also, what would you encourage the industry to do better at as it develops?
DS: I do think the industry needs to work with the politicians. You can stand on the outside and shake your fist at them if you want to. And that may be entertaining, and it may even feel satisfying at times. But it’s going to be a heavily regulated industry. Even if it isn’t regulated heavily at the federal level, it may well be regulated — continue to be regulated heavily at state levels. So we’ll see what happens there. But I think that’s the one thing is to recognize it’s going to be a regulated industry and live with it.
RG: How much it looks like alcohol right now really varies state by state. Two phenomena you have. One is some regulators just look at the alcohol regulations. And then you just kind of copy them over and change the word alcohol to cannabis and then make some other changes. That’s kind of what Washington did. And then another phenomenon, you have is state copy other states. So the first few states to get in, wrote regulations and then they would say, oh, they did it California. So you have people copying, a lot of things that Colorado, Washington, California did, whether or not those are effective policy points or not.
And federal — I mean, right now we have federally we have taxation on alcohol, as you know, and so if the federal cannabis regime also incorporates taxation, one question is how much taxation? We have no idea. That’s a question for the Congress or politicians but when you look at cannabis, effective cannabis taxes in states right now, 30%, 40% even 50% you see when you compound all the different taxes in some states. You can just do the math and you add some taxes on top of that federally, and it looks — it starts to look like a bleaker picture.
So our hope is that policymakers will consider the existing high rate — high levels of local taxation, not just state, but local city, county so forth. And kind of add it all up and say is this tenable, if you add another layer of federal tax on top of that. And alcohol taxes are not nearly as high as cannabis taxes are in the states currently? And it’s taxed higher than pretty much any other agricultural product. Dan can correct me there if I’m wrong, but I believe so.
DS: No, it’s exactly right. Plus — and what we want what — and investors can’t forget the local, the county and city ordinances and all those things. So you want to get into a cannabis retail business. And every city council says, well, here, it’s 75 yards away from a school and here it’s — half the state says you can’t — has local control and says you can’t retail here, which, of course, doesn’t mean they don’t consume cannabis there. And it doesn’t mean there’s not a lot of cannabis sold. It means that it’s illegal.
So you just have to — I mean, it’s these complications are non-ending, I think, and that’s everybody in the business has to be aware of that. We don’t see it going away, even though everybody in the business can try to help their county board of supervisors or their city council understand how complicated they’ve made things.
RS: So given those onerous regulations, I mean, I feel like it begs the question, which is the title of your book, can legal weed when there’s all these onerous regulations? Will there still be a thriving illicit market? Will that compete strongly against the legal market? How do you both see the next, I guess, like few years, maybe up to five years developing that way?
RG: Depends on how many of policymakers read our book and learn from it.
DS: Yeah. That is one of our objectives. But I would answer our question, yes. And then then the — so yes, legal, we can win. And then the obvious follow up, and I’ll say it before you do, well, what do you mean by win? And I say, continuing to have a viable growing market. But I don’t see illegal cannabis going away over your five year horizon, because I do think it will take too long for our regulatory system to realize.
The other way to go is gee, let’s start putting millions and millions of people in jail again, for violating cannabis laws. And I don’t know anybody that says, oh, let’s try to do that.
RS: I hope not.
DS: So — and I don’t think any — even people in the legal cannabis business, don’t say, pull out the National Guard and have them go.
RG: Yeah, although you do see a lot of legal producers who are calling — who are ratting out their friends down the street, because they didn’t get their license, and they’re competing. And those guys are rightfully pissed that those — that there’s a half price competition down the road that’s not paying their taxes. And so you do — I think a lot of the people have been turned in to the authorities, have actually been by competing legal businesses. But that’s — yeah, but no one thinks that’s a long term strategy for making this work.
And in particular, the ballot questions and the legislative acts that were passing all these countries had this specific goal of freeing people from prison for this thing that we don’t believe should have should have ever been a crime. And so it really undermines the entire purpose of legalization, if you end up with more illegal weed than you started with. Or if you end up having more people ending up in the criminal justice system for growing weed than you did before. That’s not a good outcome by almost anyone’s measurement. And so, yeah, legal — I want to add that I think the illegal market will continue to thrive most, in places where people are most price sensitive, so low, low income areas, where everything where people are highly budget constrained, those — that’s where you’re going to always find the most consumers who are just going to buy at the cheapest price no matter what.
And it’s going to be a long time I think before illegal weed will not be able to beat legal weed on price, as the price — the price difference might come down hope hopefully, for the viability of the legal market. That price difference between illegal and legal — if it’s illegal, it’s half as expensive as legal right now in California. That’s why you see — that’s why you’re seeing two-thirds or three quarters of the market still being illegal. If it’s a 5% or 10% difference, then you’re going to have a much more viable legal market, but you’ll still have a few people to whom that 5% means the world because they can afford a dozen eggs to feed their family.
RS: So what would you say is the like top two takeaways or things that people would be wise to pay attention to that you guys have gleaned from your research?
RG: No, I’d say number one, every state is totally different. Do not think of it as a national market yet. And number two, when it becomes a national market, be wary of this idea that federal legalization will help local businesses in any given state look at the look at the effects of competition and be ready for that and expect healthy and vigorous competition between states on price. And think about price a lot.
DS: And I would — it’s probably prior to Robins points that go a little deeper about what’s happening now. But I just want to remind everybody that the legal weed can be viable. Legal weed is a viable market. It’s going to be a growing industry. But illegal weed doesn’t look like it’s going away. So competing with illegal weed, at least for part of the legal market is something that you have to be aware of. And that will be true.
RG: Absolutely. That’s right. Yeah, from the perspective of investors, you need to be thinking about illegal, not just legal weed and the role that illegal weed plays in the market.
RS: So would you say like a legal operator, it’s kind of important to look at how much cash they have to kind of wait out the storm and try and succeed along the way as it’s a very kind of difficult path to succeed in?
RG: Definitely, I mean, I can think of very few industries where it’s more important to have a big cash cushion than cannabis. I mean, and the biggest reason of all for that is, as you say, it’s the uncertain timelines, uncertain timelines locally for licensing, uncertain timelines on the state level, unexpected things happening all the time, unexpected changes in laws. In Massachusetts, they’ve suddenly outlawed vape pens for some period of months, when there was a crisis about some people may be getting poisoned by vape products. And they just — that’s 20% to 30% of the market, they just suddenly froze that for six months.
You just have to be ready for anything in cannabis and in business, the best way to be ready for totally unexpected events is just to have a ton of cash on hand. It’s just as simple as that. And I think you need to be well capitalized. I’ve seen more cannabis businesses go under from under capitalization than for any other reason. They just can’t wait it out. They don’t have the cash they need. And people don’t want to put in more to wait two more years for something that might or might not happen.
DS: Yeah, there’s one other — I’ll just toss out one thing, and I see the time I’ve got to run. But we know this from the wine business and a few others. At least, when it comes to food, and in wine and related products, don’t try to make a living in a business where somebody else doesn’t need to make any money. So I think of the premium wine business, where you see, gee, a whole bunch of dotcom guys want to have a wine named after whatever name they make up, or movie stars or whoever.
Folks like us who might want to enter that business to make a living, it’s pretty hard to compete in a business where all your competitors don’t care whether they make any money or not. It’s a tough business to be in. So that’s something to watch out for. If we get a vanity cannabis industry, that’s something — somebody will do fine. But that’s a tough way to make a living. Racehorses is one — we can go down the list of vanity industries.
RG: I think almost all the — in cannabis, I think the vast majority of vanity industries are product brands, like whether either growers or manufactured products. And so that’s why I think there might be disproportionate opportunities, at least in some states on the non-vanity side of things like testing labs — so called auxilary services like software and logistics systems, and equipment manufacturers who are gearing their services towards the cannabis industry. But who are not necessarily even cannabis licensees, but just targeting that industry.
I mean, there’s a lot of competition already in software that plugs in to like systems like metric where the track and trace systems that states have set up that are very complicated and notoriously challenging. And so some good software companies have come up with solutions for those. They’re still not — there’s still a lot of them are not that great. And I think there’s a lot of opportunities in things like that. And as federal evolves, there’ll be more opportunities like that.
But I think distribution for example, may be less glamorous. Within cannabis licensing, licensed companies, distribution may be a less glamorous opportunity that in some areas could turn out to be better. You see — I think in general I’m a little skeptical of the future for these vertically integrated businesses. I know some multi state — some states have had vertical integration by legacy under the medical systems where there was required and some states where it’s not required. But there are these growers who are also — who are developing brands and who distributed to their own stores and sell in their own stores.
You don’t see that happening in almost any other agricultural industry. So to think that you’re going to be the Apple store of cannabis might be a pipe dream. So I’d be wary of that strategy as a longer term strategy.
RS: Fair enough. Some great insights, some great things to think about. I appreciate both of you joining us. Are you guys going on a book tour? I know people can order the book from Amazon. You want to share where else they can find you or talk to you.
RG: You can pre order the book on Amazon. We will be doing some book events. They’re not — they haven’t been released yet. So I’ll be publishing those — schedule those events on my page goldstein.faculty.ucdavis.edu. And you can preorder from Amazon. You could also order through University of California Press, the publisher, who has been awesome, and supported us through this whole process.
RS: That’s awesome. Awesome. Appreciate it. Both of you. Thanks. Thanks again. And good luck with the book. Good luck with it coming out.
Thanks so much for listening to The Cannabis Investing Podcast. Subscribe or follow us on Seeking Alpha, Libsyn, Apple Podcast, Spotify or Stitcher. And we’d really appreciate it if you left us a review on Apple Podcast. It helps other investors find our show and makes us feel fantastic.
If you have feedback or questions, we’d love to hear from you at [email protected]. Nothing on this podcast should be taken as investment advice of any sort. I’m long Trulieve, Khiron, Isracann Biosciences, The Parent Company, Ayr Wellness, and the ETF MSOS. Subscribe to us on Libsyn, Apple Podcast, Spotify or Stitcher. Thanks so much for listening and see you next time.