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Cannabis Multiple Choice: Retrench. Pivot. Explode.

I think most people can agree that in school, the multiple-choice tests were the easiest. Maybe that’s exactly what cannabis companies need right now – something easy. Over the last 3 months, the Cannabis Manufacturers Guild has had the opportunity to speak with well over 50 different established cannabis operators in Canada across multiple verticals of the supply chain. It has been an unprecedented time in the short-lived legal cannabis environment where overbuilding, lack of focus, cash scarcity, and limited investor interest has been joined by a new company ending horseman – a global pandemic.

While most businesses were quick to install a COVID response measure – limiting facility access to non-core personnel, installing new business practices, and maybe donating some PPE supplies – it has severely impacted real business drivers like demand, access to labour and ability to execute on growth projects.

The activities of LPs over the last three months in Canada can now largely be bucketed into three categories – Retrench, Pivot or Explode. So, if you are not currently in one of these modes, your task in now simple – choose the preferred answer.

In the Retrench category, producers and processors are waking up to their inability to execute on the dream of being a full integrated empire. Instead they were delivered into a Catch 22. On one hand, if they managed to build it, it is now unsustainable. If they underbuilt, they now don’t have access to finishing or barely enough to understand what to do after you build.

Aerial view of TGOD’s Valleyfield site, the world’s largest certified organic cannabis cultivation facility. (CNW Group/The Green Organic Dutchman Holdings Ltd.)

For those who built too much – too much extraction throughput, too many brands, or too much 11-13% Blue Dream or Shishkaberry – profitability is now severely impacted as cost to maintain these operations drastically outshadows the money coming through the door. Those who built too little now don’t have the working capital or focus to finish their launches, or don’t understand their consumers or how deliver the full suite of hopes and dreams promised to shareholders.

All across Canada, greenhouses are being sold off (or shut down) as the larger companies realized that controlling the cultivation space with infinite cultivation isn’t really a business strategy but more a long route way to writing off tens of millions of dollars.

The scaling game has now proven largely invalid. While there are exceptions to the rule, the Canadian consumer is still obsessed with noting the differences in Indoor, Greenhouse and Outdoor grows – not to mention discrepancies between product batches. While each grow method has its place in the market, scaling any three of these methodologies runs into conflict with demand for the other groups. For example, just because a greenhouse can grow cannabis at 75 cents – doesn’t mean consumers will treat it like Indoor and pay for it. Similarly, while outdoor had the ability to significantly reduce cost to produce, it all came at the same time – particularly when no one really needed it.

No one has found a way to undercut or out quality the competition to a point where full scaled operations make sense. There is still too much demand for choice and too little respect for what has been produced to date.

48North currently operates 100 acres of  outdoor grow in Southern Ontario.

In the end, when you have over 200 cultivators now operating in Canada, no level of efficiency in any single category of grow (Greenhouse, Indoor, or Outdoor) will allow you to take the whole market. Cultivators are now realizing it takes a balance of square footage, growing techniques and distribution channels to accomplish profitability.

It also has some growers realizing that cultivation isn’t where they should be placing their bets right now. In the theme of Pivoting, we have seen a dozen large or public LPs shut down grow in favor of adding processing space – a real industry bottleneck.

As a side note, it has always surprised me the number of LPs who significantly overbuilt in cultivation or extraction, but who forgot to add enough space for their employees to actually make the products they loved highlighting in press releases. Continuing…

Now I don’t consider adding processing space to an operation at the cost of an existing grow to be a pivot per se – it’s often just a necessity. I also don’t consider raising money under the guise of a new psilocybin business plan a true pivot either – though I’m sure they will end up with investors money. Companies truly pivoting are those who recognized their inefficiencies or ability to compete but took what they did do well and turned it into a tangible business.

I consider a company like Indiva, who recognized potential inefficiences in cultivation (as well as their ability to tap the oversupplied B2B market) and focused on the next wave of 2.0 products – edibles. Indiva was one of the first movers in the chocolate space with their Bhang product and not only did they seek first mover advantage, they also took to the market with competitive pricing that was within their ability to achieve profitably.

The company is now focused on rolling out its gummy and other confectionary lines across Canada before desiring to do more battle in the overly competitive and superficial flower market. It’s a smart move, as even Cannabis Manufacturer’s Guild has found the edibles space largely unencumbered by overbuilt operations and significant competition – though it is coming. If you make gummies now though, there is a lot of unfulfilled demand. It makes sense to place bets here.

Smart bets in cannabis at this stage of the cycle may seem like an oxymoron, but that’s likely because most investors continue to see the Explosions. CCAA processes, bankruptcies, painful dilution and mass layoffs are the examples of explosions.

There are now easily a dozen companies in CCAA or some form of restructuring in Canadian cannabis. Most companies stuck in CCAA had the illusion that while the fundamental prospects of turning a profit in cannabis continued to fall given overcapacity and competition, that time was the only thing working against their goal of raising their next round of financing.

I have seen and built a lot of financial models throughout my career in finance and cannabis. Despite so many individuals coming from banking, it has shocked me the amount of business models conducted using what I consider “napkin math”. Everyone loves showing you their “square footage x plants per square foot x premium price per gram” top line numbers. However, when you ask them what their energy assumptions are, or staffing variability on packaging, or how much working capital it will take to own 10% market share, there is always a common response: “I’ll get back to you.”

So, what prevented many companies from transitioning from napkin math to a true working model? First and foremost, if a company hired someone to create a new model the numbers always tended to get worse – a lot worse. But when a management team is raising that next round of financing, most senior management don’t like knowing there is a new internal model floating around that cuts revenue in half and severely hinders profitability. Why would anyone want to tell investors that all those assumptions used to justify spending $100 million building a facility had been thrown out 6 months later?

Whether a line of new information in cannabis was based in fact or not – if it doesn’t help the current situation, it was easier to overlook it. Unfortunately, having spoken to a great deal of ex cannabis employees in areas of strategy, business development or finance, many were frustrated in their senior managements team’s ability to take criticism for their inaccurate industry beliefs or react effectively when presented with new (often negative) information.

There was (and in some cases still is) a great deal of information asymmetry occurring within the upper ranks of cannabis. In a number of instances we have seen heads of cultivation unaware of how their product, which they spent months growing, is resonating with consumers. We have seen operation teams fail to communicate with marketing and sales departments on obvious crippling production bottlenecks. We have seen management teams unable to answer critical questions about clear business obstacles or their company’s next steps forward. All across the industry, individuals have gone rogue and installed plans of their own that in one way or another disrupted a company’s trajectory.

Why did all of these issues prop up in cannabis? I chalk it up to an inability for accurate information to flow between groups or to create realistic and constructive plans to correct errors and re-assess confidently. Individuals across the cannabis industry shifted their focus to staying employed and stopped pushing for innovative strategies that could potentially ruffle feathers. In a world where every company was obsessed with empire building, dictatorships and fiefdoms that relied on “keeping your head down and nodding in affirmation” were far more successful than the soldiers who asked why they were marching towards a cliff. That was until the whole village burnt down…

Now it’s a new world order. Being focused and being realistic are the new golden rules of cannabis in Canada. If you want money, show me a real business with cash flow potential and how every dollar gets deployed into something that will be accretive (for once). LPs no longer have to be in everything. They can pick a lane or two provided they have real assumptions and projections backed up by someone other than the guy who has been growing cannabis for 20 years. Finally, with the infrastructure already built out, new operators are willing to look at co-operative deals that increase value for all parties, not just the Empire.

DISCLAIMER: No companies mentioned in this article are clients of Cannabis Manufacturer’s Guild. Neither James Williams, nor Cannabis Manufacturer’s Guild, have ownership positions in any companies mentioned.


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