Who’s Afraid of ‘Big Pot’?

By Dan Mitchell
Jul 2, 2020
U.S. Attorney General William Barr (Photo by Win McNamee/Getty Images)

Like so many recent events, an avalanche of other, more-pressing news largely buried the remarkable testimony before the House Judiciary Committee on June 24. John Elias, a senior U.S. Justice Department prosecutor told the committee that Attorney General William Barr had launched antitrust probes of cannabis companies out of animus for the business. 

Elias, a prosecutor in the antitrust division, said Barr, motivated purely by his “personal dislike for the industry,” directed the division to investigate so many cannabis companies that the industry eventually represented nearly 30% of the cases it was pursuing. This despite the fact that the companies held “low market shares in a fragmented industry” and “do not meet established criteria for antitrust investigations.” 

That’s certainly the case — for now. But concerns over industry consolidation have been in the air since even before REC was legalized in Washington state and Colorado in 2012. The fear was that “Big Pot” would buy up or exert control over small operators, some of whom were fiercely independent, corporate-averse types from the illegal market. 

Notwithstanding the current, “fragmented” state of the industry, that fear remains. The COVID-19 pandemic has only heightened anxiety  that smaller operators will be forced out of business or into acquisitions.

The problem existed before the pandemic struck. In 2019, the industry was in crisis, with revenues falling short of expectations for many companies. Slim profit margins were getting slimmer.

“Everything that was happening before the pandemic is being accelerated,” Roy Bingham, CEO of cannabis-data firm BDSA, told me in April. He predicted there would be more mergers and acquisitions, more companies folding or being snapped up by bigger outfits, and larger companies expanding their market share

So far, though, the industry seems to be in a holding pattern. The general economic uncertainty might inspire big companies to look for attractive takeover targets, but it’s also made them hesitant to close deals. 


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Punching MedMen

It was during the rocky period before the pandemic that MedMen and PharmaCann agreed to a merger. That deal, announced in December 2018 and valued at $682M, was the only antitrust investigation Elias named in his testimony. He left nine other probes unidentified.

MedMen, the multistate dispensary operator, has made itself a punching bag for critics inside and outside the industry. Until recently, it was run by a couple of weed bros known best for their profligate spending, both on the company and on themselves.

But that doesn’t mean anyone should cheer the federal probe: essentially nobody thought the PharmaCann deal came close to violating antitrust laws. Nevertheless, the probe might have played a part in the companies’ decision not to go forward. The companies cited “regulatory delays” in announcing the deal was off. In the end, the feds dropped the investigation with no enforcement action being taken, 

Kris Krane,president of the vertically integrated Multi-State Operator (MSO) 4Front Ventures, said the industry isn’t a valid target in general for antitrust scrutiny — for now, at least. “There’s not an AT&T of cannabis,” he said, and it will likely be a long time before there is one.

But the road to oligopoly has to start somewhere, and we might be seeing the beginning of it soon. “We’re going to see more consolidation in general,” Krane said. “It’s somewhat inevitable. Over the next year or so, some companies large and small are just not going to make it.”

A Hodgepodge

Cannabis’ unique circumstances likely make consolidation more difficult. Rather than a single American industry, each legal state essentially functions as its own industry.

Companies like 4Front and MedMen are able to operate in multiple states, but it takes a lot of capital and a lot of work to be able to do so. For instance, if a Colorado-based maker of gummies wants to expand into California, they can’t just truck product to California, they have to contract with a manufacturer in that state, or obtain a California license.

Thanks to federal illegality, pot plants and products containing THC can’t be shipped across state lines. Allowing interstate commerce would almost certainly accelerate consolidation, with big companies swooping in to gain market share.

For now, a hodgepodge of state laws and regulations makes it far more complex. States now determine everything, from how many licenses get issued to which parts of the supply chain any single company can work in.

To illustrate, let’s compare Oregon and Illinois. In Oregon, where REC went on sale in 2015, anyone who meets licensing requirements can receive one. In Illinois, by contrast, there’s a cap on the number of licenses. It has led to so many problems that it plans to allow dozens of new licensees, though the total will still be relatively restrictive.

Illinois’ market is concentrated essentially by government design. But despite the free flow of licenses in Oregon, the industry there has been consolidating, too. Why? “There’s just too much product,” Krane said.

Prices and margins are low, and many small operators can’t succeed in that environment. “Bigger companies have the balance sheets to withstand years of low revenues,” Krane said. And when the market turns around — as it inevitably will — they’ll be there to reap the rewards.

Vertical Integration

Licensing regulations are all about finding a sweet spot: the right number of participants to make the market work. That’s also the case when it comes to vertical integration: which parts of the business a company is allowed to operate in. 

Allowing or requiring companies to vertically integrate — to own a farm, a manufacturing plant, and dispensaries — opens the door to big, well-capitalized businesses taking over much of the industry and supply chain. Restricting vertical integration raises costs, and thus prices. The best case for the industry as a whole, according to Krane, is that vertical integration be “allowed, but never required.”

If vertical integration is allowed, with some restrictions (such as well- and fairly-enforced antitrust rules) the market will — theoretically, at least — determine the best outcomes. Companies might want to own big chunks of the supply chain to attain economies of scale and save costs. But upon consideration, they may prefer to specialize, in manufacturing edibles, say.

For that reason, companies that can buy up the supply chain often choose not to. “The Gap doesn’t grow cotton,” Krane observed. “And McDonald’s doesn’t raise cows.”