How you define success in an undefined market

Canadian cannabis industry leaders share their insights on how to succeed in a new and untested market.

How do you build a strategy for your company in an industry that’s never existed before? That was the question facing entrants as Canada began the process to legalizing recreational cannabis in 2018.

Cannabis for medicinal purposes had been legal in Canada for several years. When the Cannabis Act came into effect on 17 October 2018, Canada became the first of the G20 countries to fully legalize cannabis for recreational consumption nationwide as well as sale and distribution to both domestic and international markets.

This was an unprecedented opportunity for Canada to be the global leader in the cannabis space, to shape the regulatory framework for cannabis around the world and to spur innovation and economic productivity.

One year before legalization, the main question to be asked was “where do new entrants into this untried industry begin?” At that time, many of the rules that would govern the recreational industry had yet to be finalized and the capacity to meet consumer demand was an unknown.

It was a critical time for the cannabis sector, and an opportune moment to ask important questions about the future. In August 2017, EY conducted a survey of licensed producers (LPs) to gain insights from licensed producers and their perspectives on opportunities for the cannabis industry in Canada.

We identified five common themes that the industry was focused on ahead of legalization.

1. Strategy and operations
   
   Generally speaking, the licensed producer’s strategy is to get set up in a way that’s conducive to attracting capital and effectively allocating resources to support growth targets and operational priorities. As a supporting layer to the strategy, their goal is to differentiate their offerings, achieve economies of scale and create a competitive advantage to mitigate the downward price pressures of commoditizing cannabis flower. LPs also understand the importance of maintaining a stable supply chain to meet demand in both the recreational and medical markets, and capitalizing on the many domestic and international opportunities.
   
   And while branding is a major component of any strategy, at that time most LPs weren’t able to fully develop their marketing strategies. Their current focus is on operations and scaling up capacity and production, which means that branding will have to take a back seat for now.
    
2. Technology and innovation
   
   Technology is often the major driving force behind the transformation of an industry and has a direct impact on the value a company creates and the pace at which it grows.
   
   While LPs have different definitions of what of technology and innovation mean, many recognized that developing or implementing innovative technologies can lead to lower production costs, higher yield, productivity enhancements, greater product quality and improved extraction methods.
   
   LPs identified three primary areas where technological improvements and innovation would be crucial to maintaining competitiveness — improvements and standardization of cultivation practices, improvements in the effectiveness of extraction technologies, and innovations that contribute to increasing the variety of delivery methods and speeding up the activation and metabolism of cannabinoids in the human body.
   
   
3. Investment strategies
   
   For many LPs, capital is mostly being allocated to building industrial grow facilities to ramp up capacity to meet the expected demand on day one of legalization. However, uncertainty about the regulations is holding them back from making long-term strategic investments.
   
   Investment in talent is also admittedly lacking. Many LPs realize that they’re not really focusing right now on talent in areas such as retail, corporate compliance, governance and branding, but they know they’ll need to if they’re going to be competitive. When companies are up and running, the war on talent will likely intensify.
   
   LPs also understand that the right investments in technology and innovation can provide a competitive advantage and help them differentiate themselves in the market.
   
   
4. Consolidation and competition
   
   One of the biggest barriers to entry into the market is access to capital. Banks aren’t currently issuing traditional financial instruments to cannabis companies. Another barrier is the speed at which the government is issuing licenses to cultivate and distribute.
   
   As for consolidation, many entrants believe it’s inevitable, leaving just a few large players post-legalization. Most don’t believe that the black market will disappear completely once legalization takes effect. The extent to which black market products will be eradicated will depend largely on the regulations — specifically the level of taxes imposed, the retail price of products, accessibility and ease of purchase. The harder the regulations make it for companies to attract customers, the greater the likelihood the black market will persist for some time.
   
   Recognizing that there is substantial opportunity in the cannabis market, it’s likely that established industries like tobacco, pharmaceuticals and big alcohol will enter this space and bring to bear their existing competencies and assets, which make them very well positioned to enter the market.
   
   
5. Customers and stakeholders
   
   Given the long prohibition on cannabis and other substances in Canada and most of the Western world, players in the sector know they’ll face deep-rooted customs and viewpoints, which could be difficult to overcome.
   
   Despite this, there is an opportunity to convert both a segment of consumers who might consume cannabis and derivative products for recreational purposes and a those who might become consumers for medical applications. How quickly Canadians can be converted into consumers will largely depend on the destigmatization of cannabis and public education around its consumption. There will need to be credible and objective scientific research to educate the public on the attendant benefits and risks.
   
   Purchasing cannabis and derivative products is still largely experiential — consumers like to see, touch, feel, smell and learn about the product they’re buying. Most LPs are unsure about future distribution channels and access points for cannabis. Many believe that, much like with more established industries, consumer demand and sentiment will dictate the type of derivative products, consumption methods and omni-channel interactions they’ll have with cannabis and derivative products.

Most licensed producers believed that the cannabis industry would continue to consolidate, leaving a few large players. They indicate that there would likely be a supply shortage in the first three years post-legalization as companies try to meet domestic and international demand. Primary methods of consumption and places of use were also expected to shift as cannabis and hemp become increasingly destigmatized and more research is conducted.