If you’ve been keeping up with cannabis industry news, you’re probably familiar with California’s many struggles. What once seemed like the “it” place for anything cannabis-related, the Golden State has been on a downward spiral for several years now. But the biggest reality to California’s cannabis industry, is that it was doomed from the beginning.
This is why so many industry experts spoke out against Prop 64 back in 2016; the state was simply not ready to take on the black market that had been thriving in the shadows of Prop 215 for the previous 20 years. And regulators did nothing to make existing challenges any better. Let’s dive deeper into what is plaguing California’s pot industry.
California’s cannabis industry at glance
California has done a terrible job managing their legal cannabis industry, and that’s putting it lightly. Sure, it’s the world’s largest market in terms of total sales, but behind the scenes, business owners from every sector are struggling.
In the beginning, there were statewide weed shortages, leading to high prices at dispensaries, and of course, customers continuing to shop on the black market.
This led to some extreme overcorrection with the state producing more cannabis than anyone can reasonably consume over the next few years, driving product prices into the dirt and resulting in minimal to no profit for retailers. Growers struggled even more to get rid of product, leaving thousands of pounds unsold, and profit loss year over year.
Dealing with Hop Latent Viroid
The state has also been struggling with a viroid that has been destroying crops at alarming rates – Hop Latent Viroid (HLVd), an infectious pathogen known for causing “dudding” or “dudding disease” in cannabis plants, characterized by:
- abnormal branching,
- poor trichome/resin production,
- leaf curling,
- lower potency (decline in THC levels by up to 50 percent),
- stunted growth, and
- overall reduced yield.
Several studies estimate that up to 90 percent of California’s cannabis crops are affected, and even though it’s not dangerous or problematic for consumers, HLVd is absolutely devastating for cultivators, costing them billions in lost yields since the viroid’s discovery.
Gavin Newsom’s “California Comeback” plan
The industry also had to take a $100 million dollar bailout from the state in 2021, known as Gavin Newsom’s “California Comeback” plan, which was intended to help growers and retailers stay in business (it did not).
And since then, the same issues persisted: prohibitively high operating costs, many hoops to jump through when applying for businesses licensing, taxes, contamination, competition, and the list goes on.
Investors have described today’s market as “brutal” and “toxic”, and several are pulling out of well-capitalized businesses because the risks just aren’t worth it anymore. And of course, this all culminates in strong competition from the black market – which continues to be one of California’s most pervasive industry problems.
Overall, legal cannabis sales have been on the decline for a few years now, and evidence suggests that this imbalance is growing, with roughly two out of every three cannabis purchases being made in the illicit market.
The Licensing Landscape
According to California’s Department of Cannabis Control (DCC), licensing is broken up into the following categories:
- cultivation licenses,
- manufacturing licenses,
- distribution licenses,
- testing/laboratory licenses,
- retail licenses,
- microbusinesses licenses, and
- event licenses.
Let’s take a look at dispensary licenses. You would think that given California’s massive population (just over 39 million people), they’d also be the most dispensary-friendly state; but that’s another misconception.
As a matter of fact, only 1,216 dispensary licenses were active as of September 1, 2023. That breaks down to around 2 or 3 dispensaries for every 100,000 residents.
Compared to states like Oregon, Oklahoma, Colorado, Montana, and Alaska, all of which have anywhere from 12 to 17 dispensaries per 100,000 residents, the problem is quite clear.
Why Dispensaries are Struggling in California’s Cannabis Industry?
The dispensary problem is due to numerous different factors including:
- the high cost of real estate,
- licensing hurdles,
- black-market competition, and
- zoning regulations.
This makes the dispensary per capita rate much, much lower than one would expect.
Zoning is a big one. Despite California’s progressive, pro-pot reputation, a total of 61% of cities/municipalities still ban cannabis retail operations within their limits. I’ve seen quite a few articles claiming that California must have a lot of dispensaries because 99.5% of Californians have a dispensary in their county.
But some CA counties are huge, like San Bernardino that has 20,068.2 square miles of land area. That’s twice the size of Vermont! You can live in San Bernardino County, or Riverside County, or even San Diego and Los Angeles Counties, and still be inconveniently far from a dispensary.
That means a huge number of consumers are faced with two choices; either drive to the closest area that has dispensaries, or buy from the local dealer – and what option do you think most people are going for?
I’m familiar with this problem myself, having lived in the Morongo Basin region of the high desert where dispensaries were outlawed, I had to drive an hour away to Palm Springs and pay dispensary prices, or I could have my dealer deliver it straight to my house for cheaper. Sadly, it was a no brainer.
However, with proper Dispensary SEO, one can stick out from the crowd and be found first on google.
Producers and Brands Can’t Navigate California’s Cannabis Industry
Other licensing niches are facing issues too. Again, cultivators are among the hardest hit and about 15 percent surrendered their licenses in 2023. Distributors and manufacturers are struggling too.
A report from 2022 estimates that distributors are waiting on $600 million dollars and counting, all from unpaid invoices that retailers are drowning in. Individual brands in the state have dropped as well, from around 1,500 registered in 2022, to less than 1,000 within one year.
“The power to tax is the power to destroy”
In the wise words of Chief Justice John Marshall. Taxes have been a thorn in the side of California’s cannabis industry from the beginning.
Cannabis sales in the state are subject to a 15% state excise tax as well as state sales taxes, which ranges from 7.25% to as high as 10.75% in some areas. And that’s on top of any local taxes that cities and counties might choose to impose.
When trying to factor in tax rates and overhead costs, while still keeping product prices low enough to be competitive, it becomes almost impossible for legal cannabusinesses to turn a profit, if they can even make it out of the red at all.
A Solution to Taxing California Cannabis Industry?
To remedy this, new laws were instituted back in June 2022. Assembly Bill 195 was passed as part of a larger statewide budget agreement in another attempt to help the dying cannabis industry. The bill aimed to:
- expand labor rights among industry operators,
- create a tax credit system,
- eliminate cultivation tax,
- change who collects excise tax from distributors to retailers, and
- increase enforcement measures against illicit operators.
On paper, AB 195 looked great. Especially for cultivators who, prior to these changes, were paying a flat rate of $10.08 per ounce of flower produced – quite a lot when we consider that the price per pound is the lowest it has ever been in the state.
Switching who collects the excise tax seemed like it would offer a huge weight off the shoulders of retailers as well. Ultimately, this bill was meant to save California’s cannabis industry when a $100 million dollar bailout only one year earlier could not. So how’s it going now that some time has passed since its implementation? The short answer, worse than ever.
Based on information from the California Department of Tax and Fee Administration, the state brought in $5.77 billion in legal sales for 2021, $5.3 billion for 2022, and $5.1 billion for 2023. That marks an 8.2 percent and 4.7 percent decrease, respectively, between those years. So the California’s cannabis industry’s downward trajectory continued even after AB 195 was signed into law.
The “grey” market
What exactly is considered illicit in the world of cannabis? What most people consider to be the “black” market is pretty clear-cut: illegal grow ops, street dealers, gangs/cartels, etc. So where does the “grey” market come into play?
The term grey market is generally used in reference to unlicensed dispensaries that may look like the real deal, but are actually operating illegally and bolstering black market sales.
Customers who shop there might not even know the store is unlicensed. I mean, why would they? How often are consumers checking the licensing information of a cannabis store they plan on shopping at? Especially if their prices and product selections are much better than their legal competitors.
Interestingly, out of more than 1000 adults surveyed by the DCC, “86% of the respondents stated that purchasing from the legal market was important, and that 72% of participants said purchasing cannabis from a licensed dispensary was a responsibility of the consumer.” However, that does not seem to be the case when applied to the general population.
Illegal cannabis dispensaries in California are hard to beat
Sadly, these stores steal a huge amount of traffic and business from legal stores, and they have better profit margins. For starters, because they aren’t adhering to state regulations anyway, they can sell products that a consumer wouldn’t be able to find in a legal dispensary.
A big one is high-potency edibles. People love strong edibles, but a legal dispensary can only sell products with a maximum of 10mg of THC per serving size and 100 milligrams total per package. That’s a whole untapped consumer base that will either purchase from illegal providers, or make their own edibles.
Additionally, grey market dispensaries are not paying taxes or licensing fees. Minus overhead and real estate costs, they’re pocketing everything else. And they can much more quickly and easily adjust their pricing and product availability to match current market trends, keeping them relevant and competitive.
Legal companies contributing to the illicit market
And to make matters even worse, there’s speculation that some legal companies are contributing to the problem by engaging in a bit of below-the-board activity; specifically, labeling several thousand pounds of consumable flower as “biomass” and selling it to black market retailers.
In an explosive interview with Benzinga, Elliot Lewis, CEO of retail chain Catalyst Cannabis Co, claimed that we need to follow the money to see what’s really going on.
“Look at quarter earnings. So they sell millions of dollars in consumer-packaged goods. That means the sh– that they actually package up goes to retail, right? Wrong!” Lewis stated. “This company produces 210,000 pounds of flower…so where’s the other 190,000 pounds going? But on the [earnings] report, they’re calling it ‘biomass.’”
Closing
If you really stop to think about it, the cannabis market is quite old and pretty stable.
The demand is still there, and public perception of cannabis use is more positive than ever in history, but we can all agree that high taxes and extreme regulation will eventually trickle down to the consumer and push them right back into the open arms of their local dealer, or the illegal dispensary or delivery service operating down the street.
This was the downfall of California’s cannabis industry, and unfortunately, it seems they still have some spiraling to do before they really bottom out.
If you’re operating in the California cannabis industry, or you plan to enter it, schedule a call with the BV to learn how we can help you build a strong cannabis brand.
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