“Almost there, Herbie. Just a few more. Let’s wrap this up. Start with Growth Rate.
In general, if the industry is growing, there is room for everyone to prosper. But be careful- what is meant by ‘growing’ is true demand, not the number of people chasing profits. Are more people consuming more weed? This includes the shift from black market to legal. It’s hard to ever really know, but the point is, do not assume demand is growing because lots of dispensaries open. They might be fighting over a slow-growing pie.
And if the growth rate of supply exceeds the growth rate of demand, eventually total supply will exceed total demand and the price (and profits) will fall. Then we see destructive behavior, such as price wars, creep in. We saw this happen in Canada.
Next, let’s look at the cost structure of the industry sector, specifically the percent fixed costs. Fixed costs are costs that do not vary with volume. You have to spend the money whether you are open or not. Rent is an example.
Other costs vary with volume, at least partially, and we call these variable costs. An example is consumable supplies, like cups and napkins for a fast food restaurant. If you are closed, you do not spend the money on cups and napkins.
The point is, if you are in a high fixed cost position, you are desperate to open up and generate volume. The classic example is an airline. Flying an empty plane is almost as expensive as flying a full one. High fixed costs. This is why airlines always have vicious price wars. So, as the graphic indicates, low relative fixed costs are good for industry profitability. High fixed costs are bad.
Next is the level of (perceived) product differentiation. Products that are largely the same are known as ‘commodities’, and they rarely command premium prices unless supply is constrained. Why do you think there are so many ‘shortages’ of basic goods?
This is also where branding and the deals people make with celebrities become relevant. If your hybrid strain is somehow perceived as better, if only because a celebrity endorsed it, and you can charge a higher price, you will likely be more profitable.
And lastly is the favorability of government policies. If regulators are friendly towards your industry, this may increase profitability. An example is ‘280E’, which refers to limits on the tax deductibility of major expense categories for companies that actually touch the cannabis. This federal rule hurts profitability, and is an example of federal laws being hostile to the industry.
“So that’s it, Herbie- for starters”.
“What do you mean, starters?" asks Herbie.
“We’ve reviewed a framework for overall industry attractiveness”, says the Mentor. So let’s say you find an attractive sector in the market you want… you still need to set up and run the business. Set up your books. Do a marketing plan. Line up your suppliers. Improve things month by month.
I will repeat a source I cited last week: In a recent episode of the podcast CannaInsider (@CannaInsider), Todd Harrison from CB1 Capital (@CB1Cap) said something very powerful… he said the industry is evolving ‘from a cottage industry to an industrial complex’. This captures things very well. On the east coast, it’s already there”.
“There is lots to think about and lots to do. So I suggest you take a break. Go fishing or something.
Here is a final summary of what we have covered:
Not everyone makes money in the Cannabis industry. As markets evolve, different challenges emerge, such as “industry overcapacity”. Conceptually, think of a series of SUVs driving individually over hills representing business challenges.
You want to continually assess the attractiveness of your chosen industry sector(s) as things evolve over time. I have provided you with a 10 item framework, that you should address with the help of qualified executives and consultants.
Our future discussions will focus on the nuts and bolts of running a business. Bye for now.”
“Bye”, says Herbie, “and thank you. I need to go concentrate on some concentrate.” And with that, the old friends part ways.