The shrewdness of Weed Inc.

Statistics Canada estimates that, in 2017, “4.9 million Canadians aged 15 to 64 spent an estimated $ 5.7 billion on cannabis for medical ( 10 per cent of the market) and non- medical ( 90 per cent of the market) purposes. This was equivalent to around $ 1,200 per cannabis consumer.” Private companies, several of them publicly listed and already supplying cannabis for therapeutic purposes, are preparing to service this soon-to-be legal market.

The federal initiative to legalize the production and consumption of cannabis has created more wealth in a few short months than what the organized crime could achieve from the illicit sale of cannabis in the same period of time. Five of the six production companies that recently signed supply contracts with the Société des alcools du Québec (SAQ) are publicly traded. As of last month, the collective stock market valuation of these five companies had reached some $ 15 billion. In 2015, before it was likely cannabis would be legalized for recreational purposes, their share prices stagnated and their collective valuation did not exceed $500 million.

The federal government argues that it is not promoting marijuana, only replacing illicit consumption with licit consumption, with more control of quality and consumption and the elimination of criminal organizations. This fragile theory assumes that the product’s retail availability, legality, assured safety and competi- tive prices will not generate a substantial growth in demand: that the number of consumers will not increase and consumption per user will remain constant.

But the logic of financial markets is simple: continuously increase earnings per share or face stagnation or declining stock prices. Companies, meanwhile, will have to convince investors/shareholders/speculators that future profits and profit margins will grow rapidly and that the market should experience substantial growth.

The stakes are high for managers and directors who have gained large, fragile, paper wealth, based on great expectations. To meet the expectations and support continuous increases in the price of their shares, they must: Quickly raise barriers to entry into the market in order to limit the number of suppliers. That’s why some are making large financial commitments to increase production capacity, and are consolidating through mergers and acquisitions. The goal is for a small group to quickly achieve a production capacity equal to, or greater than the anticipated demand over the next few years. Volume will enable them to cut costs and make them more competitive.

Negotiate long- term contracts at fixed prices with the distribution networks to lock down the market for new entrants; set the prices based on current costs plus a reasonable margin; since these costs will fall quickly as their production volume increases, these producers will post growing profit margins.

Create brands targeting distinct segments of the mar- ket. Mobilize all the industry’s resources to influence the political and administrative decisions that will determine its future profitability. This market will therefore soon consist of an oligopoly of producers and, by law, regional distribution monopolies (at least in Quebec, Ontario and Alberta). This situation, a rather unique one, will generate difficult challenges for Crown corporations mandated to act as the purchasers and distributors of these cannabis products.

Should a distributor set a purchase price equal to the producers’ operating costs to which an acceptable margin would be added, as would be done for a regulated industry? Should a price be negotiated that corresponds to the producers’ achievable costs, taking into account the impact on their costs of the very purchases contracted for by the distributor? Should long- term supply agreements be signed only if the prices are indexed to the operating costs? Should Ontario and Quebec create a buying group in order to negotiate best possible costs? Should the distributors require suppliers to disclose the identities of their financial backers?

The market valuation of the cannabis producers largely depends on the answers to these questions. An affirmative answer to all of them would cause their market value to tumble. The producers will try to play purchasers in different provinces off each other and obtain long- term purchase commitment sat a fixed price; they may also reach tacit and legal agreements with each other to set the base prices; and they will try to differentiate their products to create specific demand by consumers, thereby putting pressure on the distributors.

Ultimately the consumer price needs to be determined and, with that, consideration will be given to taxes and the profit margins distributors tack on to their costs. If the retail price is higher than the sale price of illegal suppliers, then illegal sellers will continue to control a significant share of the market. It’s interesting to note that Statistics Canada estimates 19 per cent of consumption comes from 15 to 17 year olds, who will be excluded from the legal market.

If the retail price is set l ow enough to eliminate the illegal market, there’s a risk this pricing policy will increase the demand in the legal market by attracting new consumers, or by increasing the level of consumption.

Clearly, producers will want the profit margins set by the distribution networks to be low so as to generate the highest possible demand. Pressure on distributors and lobbying of government will be intense.

While stock investors have reacted enthusiastically to this new market, creating wealth and giving the companies valuations that will be difficult to sustain, the interests of the shareholders, speculators and executives aren’t naturally aligned with the public interest. The state- owned corporations responsible for the distribution of cannabis will be at the centre of the conflict and will largely determine who will benefit: investors, speculators, management, or the Canadian public.