Will Distributors Kill the Legal Cannabis Market?

Steve DeAngelo gave an interview to Vice and raised concerns about the role of distributors under MMRSA (the set of California medical marijuana regulatory statutes passed in October 2015) and AUMA (the California ballot initiative likely to legalize non-medical marijuana).  The interview makes important points, has spurred a vibrant discussion, and we want to add our voice to the conversation.

Mr. DeAngelo’s fundamental concern is that under the MMRSA, distributors will charge high prices which will, in turn, increase retail prices and cede sales to the black market.    Under MMRSA, he said, “growers would have to sell their cannabis exclusively to a licensed distributor, which would then handle and transport the cannabis at each intermediate step in the supply chain.”  Distributors have told him that they “want to be paid fifteen to thirty-five percent of the value of the product every time they transport it. So at the very least (grower to distributor, distributor to testing lab, testing lab to dispensary), you're talking about adding forty-five percent on to the cost of the product.”  At the retail level, he says that “at a bare minimum, the medical cannabis sold under MMRSA is anticipated to be almost twice the cost of what we're selling now,” which would result in a big shift in sales to the black market, which could undercut those high legal prices.  While the AUMA does not have the same requirement for non-medical marijuana, Mr. DeAngelo believes that distributors like Southern Wine & Spirits could convince the California legislature to add such a provision after AUMA passes in the November 2016 election.

We completely agree with Mr. DeAngelo that the California cannabis industry needs to keep a careful eye on legislation to make sure that the legal market is not killed in its infancy.  Likewise, the industry must stay closely involved in the development of the regulations implementing MMRSA and AUMA.  These regulations may well be more important than the legislation, and we at CaliforniaLegalized intend to keep our finger to the pulse of the regulatory process.

But -- and we say this with tremendous respect for Mr. DeAngelo’s leadership and history -- we also think the risks that distributors will kill the legal cannabis market may be a bit overstated.  This reasons boil down to simple economics.  

To start, clarification of the terms of the MMRSA would be helpful.  It does not make distributors the sole purchasers of product at every level.   Rather, Business & Professions Code § 19326(b) requires growers and manufacturers to send their products to a distributor for “quality assurance and inspection” and for  “batch testing by a Type 8 licensee” (testing agency).  The same section expressly provides that it “does not limit the ability of licensed” growers, manufacturers, and dispensaries “to directly enter into contracts with one another” on the “price and quantity” of their goods to be distributed,” although the distributor “responsible for executing the contract is authorized to collect a fee for the services rendered, including, but not limited to, costs incurred by” the tester.  

What does that mean?  The distributors may well be an “asshole in the middle” (credit Michael Lewis’s quotation of Jim Clark)  under MMRSA.  They will charge for their “quality assurance and inspection” and transport services, as well as the testing services they arrange.  But, critically, growers, manufacturers, and retailers can still negotiate their prices directly with each other, just like they are going to negotiate the price of distribution with the distributors.

Can distributors charge so much that they kill the legal market?  Probably not, for two related reasons.  First, they’d be pricing themselves out of business.  If the legal market loses sales to the black market, the distributors will be among those who lose out on the opportunity -- unless perhaps the Teamsters have contracts with the drug cartels.  (That’s a joke!  If we disappear next week, look for us next to Jimmy Hoffa.)

Second, if the existing distributors coming in from in other industries (like Southern Wine & Spirits) charge too high a price, they will face competition offering more reasonable prices.  When we hear that the incumbent liquor distributors want to charge  “fifteen to thirty-five percent of the value of the product every time they transport it,” as Mr. DeAngelo reports, we don’t hear the swan song of the industry, we hear opportunity.  A cannabis trucking and warehousing business may not be as sexy as cultivating new strains or manufacturing innovative products, but if the existing distribution competitors are slow and overpriced, you can be sure an upstart competitor will be there to try to eat their lunch.  This is California.