Where next? Pitfalls and opportunities for Canada’s cannabis industry

Contributors:
Mario Viola - EY-Parthenon Senior Consultant, Strategy | Americas Cannabis Centre of Excellence
Gennaro Santoro - EY-Parthenon Senior Director, Strategy | Americas Cannabis Centre of Excellence

Four years into Canadian cannabis legalization, there are plenty of ways to build on the industry’s foundation and considerations to propel the cannabis market towards maturity.   

What’s holding the Canadian cannabis industry back?

As the first G20 country to legalize cannabis nationwide for adult use in 2018, Canada is often viewed as a veritable blueprint for legalization. But despite Canada’s pioneering efforts, the national cannabis sector has experienced its fair share of challenges. Now, complex market conditions are threatening the viability of operators across the value chain. What does that look like? 

Some industry stakeholders have pointed to restrictive government policies as the primary reason for the Canadian cannabis market’s volatility. A monopolized supply chain, as well as excessive taxes and cost recovery fees, are said to be adversely affecting operations. In fact, recent research carried out jointly by EY teams and the Cannabis Council of Canada called on provincial distributors to improve margin structures for provincial distributors. This report also underscores the importance of implementing faster, less costly product onboarding processes and reducing product markup rates so cannabis products can be priced competitively against the illicit market. 

Meanwhile, other stakeholders underline the damage done when licensed producers overproduce products that don’t meet consumer needs. For example, low-quality dried flower with small bud structure, low-humidity levels and low to no terpenes, which lead to a lack of smell and taste profile. When less-than-ideal products drawn from undifferentiated genetics fail to land well with consumers, some cannabis operators resort to price cuts to liquidate inventory and boost cash flow. That said, price reduction isn’t a true differentiation strategy in and of itself. And it’s known to cause downward price pressure across the broader cannabis sector. 

How can the cannabis industry mature successfully?

There’s no silver bullet answer for cannabis industry players looking to build sustainable momentum and long-term growth in Canada. What’s really needed is a collaborative approach, one in which regulators seek to improve the underlying factors that fuel industry success. And cannabis operators themselves must innovate how they operate to focus on the consumer, drive market differentiation and concentrate on the areas that offer the greatest potential ROI. 

To be sure, it’s time for regulators to consider policy changes. The cannabis market isn’t static. It’s changing quickly. Regulators must reflect that through policies meant to bolster success across the cannabis industry. Price compression has had a disproportionate impact on revenues, since most taxes on cannabis are based on volume, not price. 

What’s more, in Ontario, licensed producers (LPs) have seen their share of revenues fall by 18% since 2019. Meanwhile, the share going to the federal and Ontario governments in the form of excise duties has risen by more than 57% in the same period. That’s simply not sustainable.

Now is the time for regulators to consider a series of policy changes that reduce excise duty rates, revisit potency limitations and reassess the ways cannabis 2.0 products are taxed. Implementing these changes now could improve the sector’s profit margins and fuel product innovation in strategic, high-growth segments like cannabis 2.0. 

This evolution of the regulatory landscape can go a long way toward creating an operating environment that’s more conducive to industry maturity and long-term success. Even so, there’s a lot cannabis operators can do to seize opportunities. 

For instance, cannabis operators stand to gain a great deal by developing a deeper consumer understanding, and then doubling down strategically based on that intel. Differentiating based on price doesn’t set operators apart for long, and it won’t build brand or consumer loyalty. On the flip side, reframing to invest more strategically in the right core capabilities can position operators to strengthen brand awareness, and grow market share. 

What’s more, getting granular about what consumers want and don’t want also empowers operators to divest non-core capabilities, assets or production efforts that aren’t enhancing profitability. Doing so can bolster the industry’s overall prospects and long-term potential. That kind of insight enables cannabis operators to laser focus on winning a specific consumer by rationalizing the portfolio. At the operational level, the operator can then become more targeted in terms of producing top-performing SKUs geared to their primary buyer. Doing this now is important in order to mature. 

Investing in outside-in market assessment capabilities can generate similar benefits. This kind of assessment can help a cannabis operator translate evolving trends into innovative product offerings that increase consumer conversion and create stickiness with specific target groups.  

For example, careful analysis of grey and more mature markets, such as California, has moved some operators to launch infused cannabis pre-rolls as a new product category. Those that have done so have seen quick gains in market share and high sales volume. Using intel in this way can help operators align innovation efforts against specific market opportunities now and down the road.

Better product education is another key lever that operators can pull to maximize ROI. Naysayers may question whether cannabis operators can effectively target specific consumer groups in markets driven by THC-to-price ratios and limited by tight marketing regulations. But the upsides of doing so are already proving the theory for innovative industry pioneers. 

Case in point: after solidifying its view of what customers wanted to purchase, Carmel Cannabis successfully used product education to make market strides. This Ontario-based operator was set on establishing itself as a leader in craft cannabis production and a credible voice in this space. To do so, they’d need to bring budtenders — key influencers in consumer purchase decisions — onside. 

With that in mind, the organization launched Carmel College in early 2022. This online certificate platform was designed to provide budtenders with specific information on the impact and benefits of a craft approach to cultivation. Through the program, budtenders learned how the craft approach influenced the end product and played into pricing. 

This differentiation strategy enabled these influential intermediaries to easily and confidently describe why Carmel products should stand out in a behind-the-counter shelf space filled with homogenized, childproof packaging. And it worked. This educational platform went a long way toward solidifying Carmel’s product position on the top shelf of the cannabis industry, thus maximizing product education ROI. This is a great example of successfully using product education after solidifying a view on what their end customer wanted to purchase. 

“We wanted to establish ourselves as leaders in craft cannabis production and to be the voice to dispel ambiguities around what it meant to be craft,” said Chris Marmion, Head of Sales & Marketing at Carmel. However, as Chris put it, “for an education platform to be successful, it needs to be mutually beneficial. So, recognizing that budtenders are the biggest influence on a consumer’s purchasing decision, we wanted to draw from our legacy in cultivation and deliver insightful content budtenders would appreciate.” 

Embracing a similar approach could help other cannabis operators play up their benefits in the eyes of customers and other influencers. That builds brand, cultivates loyalty and shows a new kind of value in the marketplace.  

What’s the bottom line for Canada’s cannabis sector? 

We may be four years into legalization, but it’s still early days for cannabis in Canada, with plenty of time left to improve on the industry's foundation. The good news is Canada already has a significant head start over competitor countries in the cannabis space. Now’s the time to double down and use key learnings honed here and elsewhere to take the industry to the next level. Achieving this will require cannabis operators to develop thoughtful strategies and continuously innovate — even as the regulatory environment they’re working in continues to evolve year over year. 

To learn more about how EY teams are  supporting cannabis clients in creating profitable businesses and becoming global leaders, and how our network of experienced advisors can help in choosing the right strategies to build or strengthen your business, please reach out. 

The views of third parties set out in this publication are not necessarily the views of the global EY organization or its member firms. Moreover, they should be seen in the context of the time they were made.