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Written by Ruth Fisher

Created: 16 May 2020

• game
• cannabis
• vertical integration
• regulations
• supply chain

The cannabis industry is highly regulated, and the various regulations play a powerful role in shaping the structure, and thus outcome, of the industry. This analysis examines the following questions:

1. How do cannabis market regulations shape market structure?
2. Are the resulting outcomes favorable to suppliers and/or consumers?
3. What are the pros and cons of vertical integration in cannabis markets?

Players: Who They Are and What They Want

Let’s start by considering who the major players in the cannabis game are – the Suppliers, the Regulators, and the Customers, plus the Distributors and Testing Labs – and what they seek by participating in the cannabis industry (see Figure 1). It’s important to understand what each party wants because the what they want, together with the extent to which they’re getting what they want, will determine (i) how well they follow the rules and (ii) the actions they might take if they decide not to follow the rules.

Figure 1

Cannabis Suppliers

The players who supply product in the cannabis industry include Cultivators, Processors/Manufacturers, and Dispensaries. The Suppliers provide the products that Customers purchase and consume. Cannabis Suppliers care about three issues in particular:

• Suppliers want to run profitable businesses, which means they must be able to generate revenues that cover their costs.
• Suppliers want to comply with laws and regulations so they don’t lose their licenses to operate.
• Suppliers want to differentiate their products to attract Consumers. The primary modes of product differentiation include offering nuanced products, creating product brands, and educating Consumers.

Distributors and Testing Labs

Distributors and Testing Labs grease the wheels of the industry. Without appropriate distribution and testing services, compliant products cannot make their way through the supply chain from Cultivators to Processors and Dispensaries to be sold to Customers. Distributors and Testing Labs care about two issues in particular:

• Distributors and Testing Labs want to run profitable businesses, and
• Distributors and Testing Labs want to comply with laws and regulations so they don’t lose their licenses.

When there are enough Distributors and Testing Labs to create competition, then

• Distributors and Testing Labs want to differentiate their products to attract Customers.

State and Local Governments (Regulators)

The State and Municipal Governments are the regulators. Governments use state and local laws and regulations to achieve two goals: (i) ensuring all activity is tracked and taxes are paid, and (ii) ensuring cannabis activity does not intrude upon local communities.

• State and Municipal Governments want to make sure all product is accounted for, only licensed activity occurs, and all taxes are paid.
• State and Municipal Governments want to make sure cannabis activity is inaccessible to minors and nonintrusive to local communities.

Buyers

Consumers of medical and recreational cannabis want cannabis products that are safe to consume and that are reliable in providing the expected effects. Also, finding the “right” cannabis product to meet a particular Consumer’s needs is no easy task. So then once a specific product is found that provides the desired effects, the Consumer wants to be able to continue to purchase the same product from dispensaries. What we have, then, is

• Consumers want product safety.
• Consumers want product variety.
• Consumers want product continuity.

Read more: How Regulations Shape the Cannabis Industry