Cannabis businesses at all levels of the supply chain are realizing the complexity of the state’s distribution model
When the California Bureau of Cannabis Control mandated that all marijuana products must go through a distributor before reaching retail shelves, many long-standing businesses balked at the notion. The concept of distribution — and the value it can bring to the supply chain — needed a lot of explanation. In many ways, it still does even 18 months after the adult-use market opened.
“People think we just take something from Point A to Point B,” says Robert Weakley, co-founder and CEO of INDUS, a cannabis distributor and manufacturer in California.
In the simplest sense, distributors are the bridge between producers and retailers. But, in California, they also take on the enormous responsibility of ensuring all taxes have been collected and remitted to the state and ensuring that testing regulations and packaging requirements have been met. In addition to those core responsibilities, they must follow a slew of evolving regulations specific to distribution — not to mention the track-and-trace requirements that have yet to be implemented by the Bureau of Cannabis Control.
“Distribution is definitely the most complex part of the chain in California,” Weakley says. “This industry is still learning in a lot of areas.”
A Major ChangeThe current distribution model is considerably different than the “broker” system that was common during the largely unregulated medical marijuana era, in which growers forged direct relationships with dispensaries.
After the state announced its adult-use regulations, producers realized they would be selling cannabis to a distributor that would, in turn, sell the product at a mark-up to the retailers. Many growers opted to pursue their own distribution licenses to retain autonomy and attempt to capture the higher dollar value of selling direct to retail.
As of June 24, 2019, the Bureau of Cannabis Control listed 1,228 active distribution licenses and 591 retail licenses (including both temporary and permanent licenses) — more than two distributors per retailer. By comparison, the California Department of Alcoholic Beverages has licensed 874 distilled spirits wholesalers for more than 50,000 licensed liquor stores, bars and restaurants — roughly one distributor for every 50 alcohol retailers.
While the added responsibilities of self-distribution may not overwhelm all producers, it certainly complicates day-to-day operations.
“There was just a sheer misunderstanding about how much a distributor actually fits into the supply chain,” says Chris Coulombe, CEO of Pacific Expeditors, a distributor based in Santa Rosa. “Most people were unaware of the total requirements and complexity of their intended function, be it cultivation or manufacturing. If you couple that with also attempting to be a distributor, you’ve exponentially increased the complexity of your operation.”
Becoming the Middlemen
When Adam Steinberg co-founded Flow Kana in 2015, the company’s plan was to build a distribution service for legacy farms in Northern California. Flow Kana has raised a tremendous amount of capital — including nearly $200 million in the past couple years — which has stoked concerns about the influence and power of Big Weed, particularly among independent craft producers.
Steinberg, Flow Kana’s chief marketing officer, says the company has spent nearly four years building relationships with Emerald Triangle farmers.
“They were cautious of who to open their lives to, so it took a lot of time,” he says.
According to Patrick Finnegan, the chief financial officer of Oakland Distributing Company, many growers simply don’t want to be tied to a distribution network because they don’t want to be lost in the shuffle. Growers fear their product will be misrepresented, marketed poorly or mangled in processing and packaging.
“Remember, everybody provides the best weed,” Finnegan says. “Everybody’s product is the best. They want their product in front.”
Many cultivators got distribution licenses to ensure their products wouldn’t be competing with other brands represented by a distributor. But Oakland Distributing Company CEO Lou Viveros says some of those licensees didn’t pay enough attention to the bigger picture of compliance requirements.
“They’d get a distribution license without realizing it means quarterly tax reporting, quarterly payments, all the recording and remittance involved, and it’s never easy and quick,” Viveros says. “There’s going to be more than one cultivator that ends up losing all of their licenses because they’re not complying with their distribution license.”
Meanwhile, Weakley says dispensaries are getting accustomed to working with distributors, making it that much harder for self-distributing cultivators to remain competitive. He says retailers don’t want to buy from dozens, if not hundreds, of vendors and deal with a flurry of different invoices, different payment terms and different delivery schedules. In many ways, cannabis retail is beginning to look more like traditional retail, where businesses streamline their operations by working with fewer vendors. Almost all major retail categories rely heavily on distributors.
“The dispensaries are also looking to go into that model where they have three to five suppliers that they can get all their product from,” Weakley says. “This way they know, compliance-wise, they only have three people to call to fill the store, versus calling 100.”
The industry at large is steadily adapting to the new supply-chain infrastructure that ultimately allows farmers to do what they do best — growing quality cannabis — rather than diverting attention to logistics.
INDUS, Pacific Expeditors and Oakland Distributing Company have all seen a dramatic increase in clients with distribution licenses since recreational sales began in 2018.
“It costs more to do it yourself than to go with a distributor,” Weakley says. “What we’re seeing are people with distribution licenses saying, ‘Hey, we have a license, but we want to get out of this game. We just want to focus on our brand and relationships.’”
But Coulombe says it may be too little, too late for many cultivators to change their mind about self-distribution or those who waited too long to find a distribution partner.
“It got to a point where we had to stop accepting brands onboard; there was a three-to-five-month period where we just couldn’t bring on any more,” Coulombe says. “I think at one point we had maybe 60 to 70 brands that wanted to sign with us that we just couldn’t sign responsibly.”
Challenges Unique to Cannabis
With California having the largest population of cannabis users in the world and licensed distribution companies being a mandated link between producers and retailers, the opportunity for supply-chain-focused companies are staggering. But the traditional model for distribution is quite different than what has transpired within California’s marijuana industry.
Distributors in federally legal industries have access to myriad specialist businesses such as agents, underwriters and wholesalers that assist with in the supply chain. These companies can also use third-party shipping services such as UPS or FedEx.
In cannabis, those roles fall entirely on the shoulders of the distributor, which also pays special local and state taxes unique to cannabis. Cannabis distributors must also use their own vehicles and cannot transport more than $10,000 worth of goods in a single shipment, further constricting scale and margins.
“Just like in any other industry, distribution works on a pretty tight margin,” Weakley says. “It’s about building volume.”
Without the aid of those ancillary businesses, the startup costs to build the required infrastructure for cannabis distribution creates a financial barrier to entry, Steinberg says. Flow Kana works with an estimated 200 Emerald Triangle farms and operates both a warehouse facility and a processing facility. The company employs approximately 250 people across California.
“Distributors have to have licensed trucks and vehicles. There’s just a lot of infrastructure that distributors have to invest resources in — especially from a regulatory and compliance standpoint
to ensure you’re compliant with the state,” Steinberg says.
There are two types of distribution licenses in California: a distributor license that allows a company to move product from the producer to the retailer, and a transport-only license that allows a company to move cannabis from a producer to a manufacturing facility or to another licensed distributor. Transport-only licensees do not deliver to retail or testing facilities.
Coulombe says transport-only licensees were designed as a way for farmers in remote areas such as the Emerald Triangle to move product to the larger distribution hubs throughout the state.
However, California’s distribution model is also challenging in that distribution isn’t legal everywhere in the state. Steinberg estimates that roughly 55% of the municipalities in the state have either bans or are missing ordinances, which leaves a large section of the market untapped and limits the potential for companies to set up distribution hubs. While the state has rules prohibiting local jurisdictions from interfering with distributors transporting cannabis between licensed businesses, even the legal areas in California pose their own challenges.
“There are some localities that have close to, if not more than, 10% tax on gross receipts on top of your standard state cannabis taxes and your normal sales tax,” Steinberg says.
In spite of everything else, Viveros says his biggest challenge is the ever-changing regulations.
“I constantly talk about the three T’s distributors are responsible for: test, tax and transport. That’s what the state wants us to do,” he says. “But then they go changing rules along the way. We’re the ones responsible for making sure their changes are implemented and some of them are night and day.”
Coulombe says the bigger problem is that the state has yet to implement traceability software that was supposed to be up and running in June 2018.
“It’s all self-reported,” Coulombe says. “That’s what so crazy about the whole distribution function.”
With an annual harvest of roughly 14 million pounds, fears of illicit product entering the legal market will continue until the state implements its track-and-trace software. At that point the state would have to retroactively audit distributors’ transportation records and shipping manifests looking for small facilities that produce 10 times the average amount of flower. And that’s only if they have the staff to do so.
“The agencies don’t have all the infrastructure in place at the moment. Just like we are a budding industry, they are a budding agency,” Coulombe says. “One thing I don’t think anyone can make fun of the government for is their ability to find their money.”
Weakley expects to see waves of consolidation sweep through the Golden State over the next few years, leaving only a handful of distribution companies with enough infrastructure to service the entire state.
“I think you are going to start to see three, four key players in this space that can handle the regulations and infrastructure that’s needed,” Weakley says. “I think you will continue to see things move more into that mainstream business model.”
But the culling won’t be limited to just distribution companies. The numerous vertical operations with distribution licenses are soon going to face those same audits, but with much more ground for investigators to cover. And Viveros says the list of responsibilities for vertical operators is only growing.
“If you’re a farm and can handle all the requirements you can do really well,” Viveros says. “But over time as shelf space gets tighter, the dispensaries get more demanding and the requirements of the distributor continue to grow, you’ve got to decide if you want to be a distributor or be a cultivator, because they are different businesses.”