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Two economists’ dismal view of legalization

By Alex Halperin
Aug 18, 2022
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Source: NYPL

Until its heartstopping seventh chapter — “Legal Weed in 2050” — many cannabis executives will find themselves nodding along with “Can Legal Weed Win: The blunt realities of cannabis economics,” by UC Davis economists Robin Goldstein and Daniel Sumner.

Then, as if cresting the peak of a roller coaster, readers may find themselves holding their stomachs and questioning their life choices. I certainly did.

The cannabiz is tough, but what keeps everyone going is faith in the massive growth to come. Last year, state legal sales came in at $25B. Many prognosticators say it will triple or better by the end of the decade. Goldstein and Sumner, by contrast expect industry revenues to shrink. They don’t dispute that national legalization is coming, or that the number of consumers will grow. They argue that market forces will crush prices by 85% or more.

economics

Until its soul-shaking turn, much of the book is devoted to how the industry got this way. Goldstein and Sumner are affable guides, largely sympathetic to the legalization movement without indulging its taste for conspiracy and myth. And the conclusions they reach, largely resemble the California industry’s belief that its fortunes would improve in a lower-tax, laxer-regulation climate.

They hold up Oklahoma, where it’s said to be as easy to open a dispensary as a taco stand, as a relative success story, and devote a chapter and more to how California’s high-tax, high-regulation climate has created an unworkable mess for so many companies. The economists also endorse the industry mantra that taxes and anything else that pushes up prices sends consumers to the illegal market. They run the numbers and confirm what most industry insiders believe in their guts. 

A very important caveat

The authors recognize the unique difficulties of running a cannabis business, but then they add a very important caveat: Operating in this market keeps cannabis prices at absurd levels compared to every other agricultural commodity. Today in California, a pound of weed, in eighths, might wholesale for $2,500. A pound of Napa Valley Cabernet Sauvignon grapes wholesales for about $5.

Of course no one knows exactly what it will look like as the market normalizes and interstate trade arrives. But Goldstein and Sumner predict that as with all other agricultural markets, cultivation will move to places like Oklahoma where low taxes and regulations become a competitive advantage. 

Glass House Brands which is in the process of opening a massive 5.5M square foot greenhouse in Ventura County, says the cost of its first crop, harvested in June, was $189/pound. It wants to get that to $100 per pound by next year, with an eye on interstate trade. But in the economists’ view, interstate trade would likely shift production to someplace like Oklahoma where they can build greenhouses too, and production costs will fall even lower.

  • The bottom line: Californians bought $5B in legal weed last year. While that number hasn’t necessarily peaked yet, by 2050, Goldstein and Sumner think it could crash to $750M.

And their views have begun to catch on. In 2019, Grand View Research predicted a $146B global market by 2025. It has since revised that down several times. This week it predicted a $40B U.S. market by 2030.

Why they may be wrong

One possible way the authors underestimate the future market is through an omission. As the industry matures, they see price compression from all directions. They don’t discuss the ingenuity of companies and brands to push prices up.

Today California consumers are voting for the illegal market with their wallets, because the main difference they see between legal and illegal products is that the illegal ones cost way less. Many in the business agree and aspire to build brands with truly differentiated products. So far, no one has. But that doesn’t mean they won’t.

Differentiation can come from many different directions. It could be infusing products with a new little known cannabinoid with extraordinary properties or something much less innovative. Starbucks perfected selling $6 cups of coffee by giving people a place to sit. Differentiation should also get a boost as the industry gains access to marquee advertising and marketing channels.  

But weed can’t go on selling for $5,000/pound retail. This helps explain why the industry is so excited about drinks, which can cost 15x as much as a gummy per milligram of THC. (Drink sales haven’t yet lived up to hopes.) 

Sumner and Goldstein don’t expect to be right about everything, but they are extremely smart economists. Operators ignore them at their peril.