Examination of the pros and cons of provincial cannabis distribution

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The centralized and provincially mandated distribution of cannabis in Canada is gaining momentum.

In Ontario, the OCS (Ontario Cannabis Store) suffered a data breach last May, followed by a recent online attack against its fulfillment center operated by a third party, Domain Logistics. And in British Columbia, industrial action led to the suspension of orders by the centralized cannabis distribution warehouse.

Unsurprisingly, the industry is now seeing a healthy debate about the pros and cons of centralized provincial distribution, and in particular “monopsonies,” where there is only one buyer.

“In Canada, producers pay a higher margin to monopsony distributors who act as a single buyer and set prices for finished packaged inventory at wholesale,” says Dan Sutton, founder and CEO of Tantalus Labs in Vancouver. “In a fledgling industry, this arguably simplifies a grower’s ability to access all retailers in a given province, although in practice stores that stock and sell produce still require ongoing sales relationships. “

Sutton notes that, compared to direct delivery models, the cost and margin captured by provincial distributors is high.

“The real value provided by inventory warehousing and distribution is not reflected in provincial profit margins,” he says. “Thus, provincial markups essentially act as a tariff, increasing deadweight loss and reducing competitiveness with the illicit market.”

However, centralized government-run systems have distinct advantages. Many retailers appreciate simplicity. Producers don’t have to place hundreds of different shipments to retailers – or, perhaps worse, to distributors who engage in predatory practices. There are also advantages for small suppliers.

“There’s always the question of why government monopolies manage the distribution of packaged goods,” says Audrey Wong, founder and CEO of Zyre Brands in Vancouver. “However, this model actually has many advantages that people need to recognize. I am a very small local owner operated business. If it hadn’t been for this model, which removes pay-to-play at BC’s largest retailer—that is, government stores—I probably wouldn’t be on their shelves. And if I was on their shelves, I’d probably be trading on price at a level that’s unsustainable for a small business, because I don’t have the economies of scale.

Producers also benefit from simplified invoicing and the ability to ship all of their products to one location.

“In a centralized system, I ship everything to one place and get paid 30 days later,” says Abyan Schupp, who oversees sales and operations at Organicraft, a licensed producer in Vernon, British Columbia. “Otherwise, I have to send four cases to one store, two to the other and five to the other, which costs me countless hours as a salesperson. I have to look up the invoices, and my accountant and CFO have to add them and reconcile the books. It was something I had to do in Saskatchewan all the time.

Saskatchewan is an interesting example, as the government has pulled out and allows growers to ship directly to retailers or work with competing distributors.

“Saskatchewan offers its own unique challenges,” says Gord Nichol, owner and president of North 40 Cannabis in Nipawin, Saskatchewan. “You don’t have to convince a government council to buy your product – rather you have to convince every store. However, as a small independent producer, I much prefer this system rather than trying to convince a board of directors. In my opinion, it is easier to sell to a store than to a board, simply because the store is closer to the end consumer and will be more in tune with demand. »

A distribution system like the one in Saskatchewan also allows for much more flexibility.

“I’ve been in situations in Saskatchewan where a certain SKU had finished its cycle, and a retailer was having trouble moving it,” says Schupp of Organicraft. “I could offer a discount on a new product, and they could combine the margins and sell both at the same time. It was easy. You can fix issues on the fly.

Dropshipping promises an opportunity for greater price flexibility. British Columbia, for example, recently launched its own direct-shipment program, which is focused on indigenous and small-scale producers. Under this new system, the 15% BCLDB surcharge will still apply.

“Ironically, BC’s drop-shipping model adds flexibility for small-batch offerings aimed at local or specialty stores, but maintains the high tariff cost of participating in the provincial cannabis market,” says Sutton. “Dropshipping that keeps prices high keeps deadweight loss, makes legal cannabis more expensive than its illicit competitors…and adds no value to the supply chain.”

And the answer is?

As jurisdictions in Canada continue to tinker with their distribution models, it is fair to ask: what is the best system? For some observers, it is a hybrid structure that allows private distributors to participate in direct delivery.

“In a hybrid model, small producers without sales teams can choose to work with one of several distributors who are forced to price their service competitively,” says Sutton. “And more mature growers can deal directly with an increasing number of resellers as demand for their product grows.”

A hybrid model that includes direct delivery allows for flexibility in the relationship between LPs and retailers. It also avoids extreme market distortions, as can happen with large monopsonies like the OCS.

“I can’t tell the OCS what I have available – they just tell me what they want,” says Schupp of Organicraft. “For example, when we launched our Platinum Grapes SKU, it sold out immediately. The OCS saw this and sent me three purchase orders which amounted to 52,000 units for the month of July. It’s 300 pounds. We are a micro business and can’t grow that much at the moment, but because I can’t deliver it, I’m penalized – my supplier rating has gone down.

This issue may even affect future listings, as the OCS algorithm may determine that the Organicraft SKU is not selling as well as it should, based solely on the volume that should have been ordered. This type of dysfunction is likely reduced when concurrency is introduced into a hybrid distribution model.

“As long as there is more than one distributor in a given market, those distributors are obligated to price their services competitively,” says Sutton. “Competition from a hybrid model reduces the distribution margin to a product value over time, reduces the risk of a single point of failure, and allows producers to adapt to more direct relationships as their business grows if they want to.”

Sutton argues that while a centralized distribution model may seem to simplify the supply chain for producers, they still need to maintain sales relationships with their stores and perform internal demand planning. They also bear the financial burden of returns if a product ages.

“It’s not hard to sell directly to 50, 100 or 500 stores,” he says. “Companies from breweries to bakeries to hobby farms are doing it every day with much fresher go-to-market obligations.”

A hybrid model could also help break down barriers to small producers and interprovincial trade. Since Ontario is Canada’s largest market, producers want to get in, but it’s not always so easy.

“There are hundreds of stores in Ontario that want my products, but I can’t get in,” says Nichol of North 40 Cannabis. “The OCS wants me to buy a $15 million recall insurance policy, which costs $50,000. This works well for larger companies that can afford it – but it really works as a way to keep small businesses out of the market. It’s completely disconnected from our sales volume and revenue.

And there are also challenges with British Columbia.

“British Columbia had an opportunity to make gains by allowing direct delivery from producer to retailer,” says Nichol. “They did that – then they slammed the door on out-of-province suppliers. Interprovincial trade barriers are a terrible thing. As soon as the government gets involved, it erects these barriers. I would love to see Saskatchewan close the doors to BC wines for a month and see what happens.

Policy issues aside, the main recent argument against big players like the OCS and the BC Liquor Distribution Branch (BCLB) monopolizing warehousing and distribution is that when they fail, that’s it. the failing system.

“As seen recently in the OCS data breach and the BC Liquor Distribution Branch labor dispute,” says Sutton, “this single point of failure compromises the industry’s ability to keep products on the shelves. ”

More generally, however, it may be important not to throw the baby out with the bathwater. Here, the Zyre Brands example is instructive, given that the company has a unique offering that sells flavored vapes based on their “vibe.”

“The BC LDB looked at my product simply on its merits,” says Zyre’s Wong. “They saw it was a one-time deal and said ‘I like it, I’ll take it. Whereas if it had been a private model with a big chain store, they could have said “I love it, but what do I get for wearing it?”


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