How Ontario is killing cannabis retail
Razor-thin profit margins, supply chain hoarding and licensing fees are pricing legal retailers out of the market
Three years after legalization, the reality of Ontario’s cannabis industry for retailers is far darker than our wildest imagination.
Ontarians rejoiced at the prospect of being able to enter the market in its infancy when the Ford government announced plans to allow privatized retail sales of cannabis. What nobody realized was how corrupted the industry would turn out to be.
Ontario Cannabis Store’s virtual monopoly
The Ontario Cannabis Store (OCS) was originally supposed to be the cannabis equivalent of the LCBO – the sole distributor and retailer of cannabis in the province. Ford’s administration changed those plans but with one caveat: the OCS would serve as the sole e-commerce retailer, and private companies would operate brick and mortar stores.
This was supposed to be a temporary measure to ensure all Ontarians had access to legal weed while bricks-and-mortar stores could be built.
But three years later, the OCS continues to be the sole distributor – and the main supplier – of licensed stores who have had the financial disadvantage of having to invest heavily in application fees, security systems, and overpriced real estate.
The OCS is also their main competitor.
There’s a benefit for retailers to having OCS as a supplier – they all pay the same price for the same product. This takes control of supply away from licensed producers that either own or have a stake in retail stores.
If retailers were permitted to purchase directly from producers, large chains like Tokyo Smoke, for example, which is owned by Canopy Growth, would have the power to undercut their competition.
But as it stands, a licensed producer can only own up to a maximum of 25 per cent stake in a retail store. But, that regulation hasn’t prevented Canopy Growth, for example, from the franchising of Tokyo Smoke. Meanwhile, Sundial Growers, a licensed producer from Alberta, recently purchased Spiritleaf and recently signed an agreement to buy Alcanna, which owns and operates Value Buds stores.
On the other hand, the OCS sells products to retailers based on its own retail price. The OCS’s wholesale price is a fixed markdown, but it’s still profiting from the wholesale price. That is a great disadvantage for retailers, who must pay labour costs, rent, utilities, security, and credit card processing fees.
You may say, “business is about volume.” And you would be right, until there are five stores in a two-block radius, and the OCS is still the only delivery option.
Stores that opened under the old lottery system had the advantage of having the market to themselves for almost a year. But there are now more than 1,000 licensed stores in the province, with 80 new licenses a month being granted. Ontarians like weed, but not that much.
Undercutting retailers
The pandemic has introduced many changes and challenges for retailers.
During the first wave in the spring of 2020, the OCS began offering free delivery throughout the province. The OCS also doubled down on same-day delivery for an $8 fee in select cities with the highest number of licensed retailers.
Retailers just won the right to deliver, but the change has still to be legislated. Why would the OCS compete with its retailers in markets that have plenty of brick-and-mortar options while it continues to charge outrageous delivery fees to retailers that have no other option?
To be fair, the province has allowed retail stores to provide delivery services at two different times during the pandemic. But this came with strict rules.
Retail deliveries must be carried out by an employee of the store. Meanwhile, the OCS can use a third-party to deliver.
Retailers must also deliver directly to the person who placed the order and ensure the ID is checked and the credit card used for payment is verified.
At the peak of the pandemic, retailers could only deliver until 8 pm. Any orders not delivered by this deadline must be returned to the store. The OCS has been delivering as late as 11 pm. Although stores can now deliver until 11 pm, the issue is that technically if it’s past 11 pm, the employee must abandon the delivery and return the product to the store. Score that: Private retailers 0, OCS 3.
Moreover, the OCS’ e-commerce business is operated with a complete disregard for the environmental and financial problems that arise from shipping to the entire province from a single warehouse.
Yes, when a customer from Thunder Bay orders, it is shipped from the warehouse in Guelph, yet there are many stores in Thunder Bay that could simply deliver around the corner from their location.
Hoarding high-volume product
The consumer has spoken, and the cannabis market is now divided into three segments: customers looking for value, premium, and high-end products. These three categories have different markets.
Where the OCS has failed is in identifying these segments and securing enough supply for stores. The OCS hoards the high-volume products for its e-commerce operation while stores are out of stock.
Why don’t retailers just order more when it is in stock, so they don’t risk running out? The answer is that the OCS places limits on the quantities each store are allowed to purchase
The OCS is also purely cash-on-delivery, meaning that a retailer must pay for the product on the day they receive it. There are no payment terms, no credit card payments, nothing. The payment is withdrawn from the retailer’s bank on the day of delivery. With razor-thin margins, retailers must control their inventory tightly.
Lack of product rotation at the OCS warehouse means retailers may receive a product packaged months before its delivery date. This is extremely frustrating, as consumers demand the freshest possible product.
In the normal business world, if you are unhappy with the product delivered, you can return it, no questions asked. In Ontario’s legal cannabis industry. Retailers are often given a song and dance about Health Canada regulations around cannabis shelf life, blah blah blah.
Transparency is an unknown word to the OCS. It is all left to the wrangling and negotiating of each individual producer.
Pay to play
The majority of licensed producers currently listed with the OCS are very large publicly-traded companies, but there are hundreds of small micro-cultivators in Canada who are not given a chance to sell their product. There’s this thing called pay-to-play.
Large retailers demand payment from small producers for shelf space. This is masked as remuneration for data, but producers have no option but to oblige or be shut out from large retail chains, some with upwards of 50 stores in Ontario alone. Many smaller producers are not able to afford the cost and they can’t even find an agency to represent them.
Additionally, the OCS is now delisting hundreds of products. This will cause many more write-downs for already struggling producers.
Most people in the cannabis industry bring up the “send us what you can” joke. Yes, the OCS has and does place orders with licensed producers by saying “send us what you can”.
The province has also announced it would allow licensed producers to operate “farmgate” retail stores at the production facilities, similar to what breweries and wineries do. So far some six applications have been approved.
Compliance conflict of interest
Cannabis stores are pretty similar to corner stores or liquor stores in terms of operations. All cannabis products are received and sold as sealed packages. There is very little creativity needed to provide the basic service.
Yet, the provincial agency tasked with licensing retailers chose to make the process extremely expensive and time-consuming. Criminal background checks and financial stability confirmations are required. Being subjected to the sort of scrutiny most individuals and corporations had to go through, just ensured the underprivileged had no chance of entering the industry, as did the $6,000 application fee for a Retail Operator License.
Deloitte, PWC, KPMG are tasked with performing the background checks. Having a third party do the heavy lifting is perfectly acceptable, but these third parties are also in the business of consulting for cannabis firms looking to enter the retail market.
Deloitte purchased Cannabis Compliance Inc. in late 2019. CCI is a cannabis consulting firm that has plenty of retailers as clients.
Once an applicant has been approved for a retail operator license, they must shell out another $4,000 application fee to receive a retail store authorization. It really starts adding up.
By comparison, liquor license applications cost $1,150 and there are bigger risk factors in serving alcohol than there are in selling packaged cannabis over the counter. Could it be that the pricing is meant to deter from applying in order to aid the larger corporations with deep pockets?
The biggest head-scratcher is the cost for an individual to apply for a manager’s license.
This license is strictly for people who want to be employed in a retail store in a management role. Retail store managers are usually people who oversee staff, place orders, count inventory, etc. A manager is an employee, yet the AGCO requires a $750 application fee. A criminal background check with Toronto police is $20 and a credit report is in the $25 to $30 range.
Turns out, if you want to make a staff schedule, you have to be perfect. Traffic tickets, financial difficulties, civil litigation, bankruptcies, overdue taxes, anything really, could make the application for a manager license take months. For what? A $50K to $70K job?
Asking officials, the answer is always the same: we want to prevent people from using the legal market to provide for the illegal market.
Why would anyone in the illegal market want to enter the legal market? There are dozens, if not hundreds, of illegal delivery services doing phenomenal business without the restrictions, regulations, and reporting required of the legal market. The risk of criminal charges is next to nil, as the owners of CAF have proven.
Their stores continue to operate normally, even during a pandemic. The CAF location at 104 Harbord actually won the second allocation lottery in August 2019. The AGCO and its third-party consultants did not disqualify this location. Instead, this lottery winner was permitted to move to the proposed location (something that was technically not allowed in the rules of the lottery).
Unlicensed dispensaries have multiple advantages over the legal ones in Ford’s poorly constructed legal cannabis market. Packaging, marketing, advertising, and THC levels in edibles, everything consumers want, they can get in the illegal market, but not in the legal one.
The licensed producers are being impacted negatively by these operations. The oversupply in the legal market is going to have a terrible effect on the balance sheets of these companies and the ones to pay the price will be the employees that will be laid off.
J.C. is a licensed retailer in Ontario.
Updated on Sunday, October 31 at 4:34 pm: An earlier version of this article contained incorrect information about the number of farmgate stores currently approved by the province.
@nowtoronto