The Ultimate Guide to Vertically-Integrated Cannabis Businesses

Nov 25, 2020 | Cannabis Business

Vertically-integrated cannabis businesses successfully operate in the cannabis sector. But what’s so special about vertical integration in cannabis?

Vertical integration in the cannabis space ensures your operation runs like a well-oiled machine. Consumers receive higher quality, fresher products––without the hefty price tag. This comes from the control you have over your operations.

So how do vertically-integrated cannabis businesses work?

Vertically integrating your canna-business means you own all parts of the supply chain. In essence, you’re in control of all costs, allowing you to determine the final price on your products and maintain all value from the ideation stage to sale.

In the battle of vertical integration vs. specialization, it’s crucial to consider the benefits of specialization too. Depending on the business model you choose, you could make your business more efficient and decrease your costs. Simply put, the right business model will make your company more competitive.

Curious about how vertical integration or specialization could work for your cannabis business? Contact us at any time for guidance. 

Between cultivation, manufacturing and processing, retail, and distribution cannabis business licensing available, a lot is going on in this sector. But the business model that’s not often discussed is vertical integration in cannabis. This involves operating a business across all verticals to keep as much value as possible.

Let’s discuss vertical integration for cannabis businesses, how it works, what it means, its benefits, and more.

What Does Vertical Integration Mean in Cannabis?

What is vertical integration anyway? This business model enables companies to maintain control over their product throughout the entire process––from creation to distribution to retail.

Eventually, you’ll sell your product to end-users. If you’ve ever heard of seed to sale or Farm to Table, this is basically how it works. Vertical integration for cannabis involves growing the cannabis, processing it, distributing it, and selling it to consumers yourself.

Since the cannabis space is still expanding, it’s still developing terms to discuss how operations work. But it has adopted the term “vertical integration” because it means the same across all industries.

For instance, if you own a cultivation operation, it’d probably be beneficial to complete the supply chain. This would involve starting a lab for extraction or processing, a location for manufacturing and distribution, and a retail shop to sell to consumers directly. Each vertical works with each other, allowing you more control over each stage of the seed to sale process.

For a cultivation facility, you’d grow plants until they’re mature. As soon as they’re ready to harvest, you’d have a team cut the plants and prep them for the lab and extraction facilities––or to sell to consumers.

When the cannabis plants reach your lab or extraction facilities, the team removes cannabinoids for edible or concentrate production. But if you keep the plant in flower form, it’s sent to your manufacturing facility for weighing, packaging, and labeling.

After the products are labeled with local state law compliance a priority, it’s ready to travel to retail or medical shelves. As you can see, vertical integration in cannabis means you own all aspects of the process.

Vertical integration vs. specialization

In the fight of vertical integration vs. specialization, it’s essential to know that these two business models are opposites. While vertical integration can work for some, specialization is the right move for others.

But should you vertically integrate or specialize in a particular vertical?

Does Vertical Integration Work for Cannabis?

Vertical integration ensures you gain more say over how your supply chain operates. This can involve either purchasing existing businesses, creating and developing partnerships with them, or establishing new enterprises.

While vertically integrated canna-business can work in the same state, we’re seeing more canna-companies spreading the span of their operations across state borders and into other regions to reach more people.

Possessing a retail arm is typically viewed as a critical component of any vertical integration plan for cannabis. This is how your business will have direct access to end-of-the-line consumers.

As we observe a trending shift towards purchasing online, becoming active on e-commerce platforms is increasing in popularity. The role online purchases play in vertically integrated operations has grown significantly since the COVID-19 pandemic began, and it’s not likely to fade away any time soon.

However, the way this works for you can be contingent on where you’re located because implementing vertical integration in cannabis differs from state to state. For instance, some states––like Washington––don’t allow vertical integration. However, in states like Florida and New Mexico, vertical integration is required.

Why are some states mandating or banning vertical integration in cannabis?

States banning vertical integration are afraid because of what happened with alcohol before prohibition. Prior to prohibition, alcohol manufacturers formed sheisty business partnerships with bars. This promoted excessive consumption and decreased the competition, effectively putting some companies in control of everything related to alcohol.

To minimize these shady practices, alcohol post-prohibition regulations banned vertical integration in the alcohol industry. The states banning vertical integration are now fearful of cannabis business monopolization that could result in a decrease in competition. These states believe that this can damage the industry, making it more challenging for small businesses to enter the market because of the excessive upfront capital vertical integration demands.

However, some states believe in mandating vertical integration because they think it permits more oversight and control of the seed to sale process. Furthermore, some states claim that it helps to reduce purchases from the black market because requiring vertical integration forces the businesses to produce, manufacture, and distribute their own products.

Why support or avoid vertical integration in cannabis?

People operating in support of vertical integration also highlight that federal tax issues are resolved. For instance, since cannabusinesses aren’t allowed to deduce regular business expenses under Section 280E of the Federal Income Tax Code, they vertically integrate to share their overhead costs across multiple businesses. Rent and utility costs are split between vertically integrated businesses, thus relieving the 280E burden.

In Colorado and Oregon, cannabis vertical integration is allowed. But neither of these states demand it in the cannabis sector.

While this can work for cannabis, it’s not always an option. Sometimes, cities cease licensing for specific license types. For example, some cities only permit a certain number of cultivation or retail licenses.

Some people prefer to avoid vertical integration too. For instance, craft growers and small scale businesses servicing certain niches within the cannabis sector can become stressed if they attempt to integrate vertically. If required, these small operations are then pressured to build out their businesses––sometimes, while lacking the appropriate capital to make it work.

Vertical Integration in Cannabis: Why or Why Not?

Advantages of Vertical Integration

While the disadvantages of vertical integration can dissuade some people from participating in it, this business model comes with several key advantages that make it appealing.

Don’t bypass the benefits of vertical integration just because of some potentially problematic aspects. Here’s what you can expect when you vertically integrate your cannabusiness:

  • More control. Business owners who vertically integrate have control over their whole production process. This can usually translate to producing products at a cheaper cost, and this can help you bring your costs––and your consumers’ costs––down significantly. In turn, your operation can become more competitive and receive a larger market share. You also control the prices because you no longer have to worry about including third-party product and service providers in your operations.
  • Better quality. Quality control is easier to manage when you have and maintain complete control over your production. You’ll have more opportunities to improve your accuracy, and this can translate to providing the higher level of quality consumers expect from a top-notch cannabusiness.
  • More savings. Vertically integrated canna-companies have the potential to save on overhead costs. Between rent and utilities, sharing these costs makes having multiple operations less expensive for each business.
  • More reliability. By bringing cultivation, manufacturing, and retail together, your supply chain becomes more reliable than when these verticals run independently of one another. Your retail and processor components are given access to high-quality raw materials and finished products, and the cultivation facet doesn’t have to worry about finding someone to purchase the yields.
  • Greater economies of scale. Since vertical integration can lower overhead costs and increase your profitability, you can drastically improve your economies of scale. You can increase your cash flow, allowing you to reinvest more money into your business. Increases in profits can also enable you to purchase state-of-the-art equipment to improve your output and efficiency in processing, extracting, and manufacturing. You also have the option to expand horizontally by purchasing or opening more facilities, increasing your capacity. Thus, you’re capable of utilizing greater economies of scale.
  • Control over supply and production plans. Operating a parent company allows you to monitor your retail outlets’ sales trends and plan for your future. Since you have more control over your planting and manufacturing activities, you’ll make decisions on your supply and production plans that can vastly improve your processing and stocking efficiency.
  • Faster adjustments. Vertical integration also permits rapid changes to product offerings, allowing your business to stay ahead of the competition. For instance, if Gorilla Glue is soaring out of your inventory, your retail team can reach out to your cultivation team to adjust the supply chain to meet those needs.
  • Technology leveraging capabilities. Instantaneous data sharing in this digital era ensures you can coordinate your management and administrative functions effectively. Operating a vertically integrated company streamlines decision-making, lessens overhead costs, and achieves new levels of efficiency. Real-time communications between each vertical can improve most aspects of your operations.
  • Effective structuring to create, promote, and sell branded products. Launching your own line of branded products becomes more straightforward when you control all aspects of your cannabis operation. While it’s challenging to break into a crowded marketplace, vertically integrated companies bypass the barriers. Since you’re using your cultivation, production, manufacturing, extraction, distribution, etc., you know the quality is on point. This is critical for those seeking to establish a solid reputation for a new brand.
  • Attractive to big investors. For business operators interested in an M&A for their cannabusiness, significant investors find vertical integration appealing. These are the investors who are looking for plug and play models with proven track records. Vertically integrated cannabis businesses are usually acquired at a premium because it’s challenging to build a cannabis supply chain, integrate teams, implement systems, and handle other aspects of creating these operations.

Disadvantages of Vertical Integration

Controlling the entirety of your supply chain sounds great when considering the benefits of vertical integration for cannabis. But the disadvantages are equally important to note.

Keep the following cons in mind if you’re considering vertically integrating your cannabiz:

  • It’s expensive. Cannabusinesses considering vertical integration must have or raise significant capital to make it work. This means it’s incredibly challenging for small businesses to enter the cannabis industry in states that demand vertical integration. For these smaller operations, it can be overwhelming to handle all the requirements from a financial standpoint.
  • “Jack of all trades, master of none” scenario. Sometimes, it’s best to specialize in a single vertical rather than specializing in all of them. While it’s possible to specialize in various verticals, this usually requires time and experience operating in each vertical before becoming a master.
  • State requirements can prove problematic. For cannabis business owners operating across multiple states, variances in state requirements can be challenging. One state could demand vertical integration while another could ban the practice. With this in mind, multi-state operators have to adjust their business model accordingly, which takes a lot of time and money to implement.

While valid pros and cons for vertical integration in cannabis are essential to consider, you can weigh them together to determine whether you can improve your business by vertically integrating. Regardless, you’ll still need to determine whether the business model will work in the state(s) you operate in.

Is Vertical Integration the Right Approach for Your Cannabis Business?

Even though the cannabis sector will always have space for specialized companies, motivated entrepreneurs and management teams can succeed with vertical integration. The benefits of vertical integration for cannabis are easy to see. But it’s critical to consider the location of your operations and potential cons before committing to vertically integrating.

Interested in growing your cannabis business? Contact us today for an analysis of your specialized or vertically integrated canna-company.

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