The cannabis industry is still developing, as is the jargon used to talk about it. Vertical integration is a common term used for businesses across a wide variety of industries, but what does vertical integration mean for cannabis? Being vertically integrated means a business owns all stages of their supply chain, instead of working with a third-party. For example, Apple manufactures its own touch ID fingerprint sensors, LCD screens and other components of their phones. They also own their own manufacturing facilities that put the pieces together to form the finished product. Apple stores around the world sell Apple products, which complete the supply chain. From start to finish, Apple control’s its own production process. This is vertical integration.
In the cannabis industry, vertically integrated businesses own the cultivation, lab/extraction, manufacturing and retail sectors of their business. Each vertical works in tandem with one another to streamline the seed to sale process.
Starting at the cultivation facilities, the plant grows to maturation. Once ready for harvest, the team cuts down the plants to prepare them for the lab and extraction facilities or end the consumer. In the lab/extraction facilities, the cannabis plant goes through an extraction process to remove the cannabinoids for edible or concentrate production. If the plant remains in its flower form, it travels to the manufacturing facility where packagers accurately weigh out and label the cannabis. Once labeled in compliance with local state laws, the final product is ready to hit the retail (or medical) shelves. In a vertically integrated business, the company owns all sectors of this process.
Vertical integration has its pros and cons, but for some cannabis businesses, the choice to vertically integrate is in the state’s hands.
Why do some states mandate or ban vertical integration in cannabis?
States that mandate vertical integration claim it allows for better oversight and control of the seed to sale process. In addition, some states claim it helps reduce retail facilities from purchasing black market products, as the businesses are required to produce, manufacture and sell their own products. Proponents of vertical integration also argue that it helps remedy the federal tax issues that exist because cannabis businesses can’t deduct regular business expenses under Section 280E of the Federal Income Tax Code. Vertically integrated businesses can share overhead costs like rent and utilities if properly handled, which helps relieve the burden of 280E.
States that ban vertical integration source alcohol pre-prohibition fears. Before prohibition, alcohol manufacturers developed shady business partnerships with bars and promoted unhealthy over-consumption and lack of competition. In an effort to rectify these practices, alcohol post-prohibition regulations prohibited vertical integration within the alcohol industry. States that ban vertical integration source the same fears of cannabis businesses monopolization and decreased competition as reasons to ban the practice. In addition, it’s difficult for small businesses to enter the market due to the high upfront capital required for vertical integration.
While some states require or ban vertical integration, a handful of states leave the choice up to the businesses. For those states, cannabis companies can weigh the following pros and cons of vertical integration to decide if the structure is right for the goals of one’s business.
Pros and Cons of Vertical Integration
- As businesses that vertically integrate control the entire production process, companies can produce their products at a cheaper cost.
- Flexibility in the production process creates opportunities for cost-saving measures.
- Complete control of the production line ensures better accuracy and tighter quality control.
- Vertically integrated cannabusinesses can potentially save on overhead costs like rent and utilities.
- Vertical integration allows for fast changes to product offerings. If Sour Diesel is flying off the shelves, the retail team can relay this to the cultivators who can adjust their supply accordingly.
- Businesses must raise a significant amount of capital to vertically integrate. Small business owners have greater difficulty entering the market in states that require vertical integration due to limited resources.
- While it’s possible to specialize in all vertical sectors, opponents argue vertical integration makes businesses a “jack of all trades” versus a master of one craft.
- Multi-state operators face challenges in the variance of state requirements. If one state requires vertical integration and one bans the practice, multi-state operators must adjust their business model, which is a laborious and costly undertaking.
Vertical integration is a business model that each state will have to decide whether to allow, mandate or ban. When federal legalization takes place, a nationwide requirement may be enacted, or the federal government may leave that choice in the state’s hands. With valid pros and cons for vertical integration in cannabis, it’s likely to remain a hot topic in emerging and established markets for years to come.
If you’re a job seeker looking to join the cannabis industry, understanding the vertical integration structure within cannabis can help you stand out from the other candidates. Being able to show you understand both the flow of vertical integration and your state’s laws demonstrates to potential employers you’re interested in staying informed about hot topics within the industry. Want to check out other educational resources? Browse our blog for topics such as common cannabis acronyms and requirements to work in the industry by state.
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