Trade War on Drugs

Additional cost on packaging and vape cartridges threaten already-tight margins

With the Trump Administration’s growing trade war with China now affecting more than $200 billion in products across multiple sectors of the economy, it was only a matter of time before its effects began to ripple through the cannabis supply chain.

The president’s 25% tariffs on Chinese goods are hurting profits at farms, processors and distributors as many buy their packaging from China and even more pack their extracted oils into Chinese vaporizer cartridges.

The effects of the tariffs came as a surprise to cannabis businesses that are already strapped for cash and highly taxed.

“It was a complete shock,” says Julia Jacobsen, CEO of Aster Farms in California. “We were just really not expecting this.”

“We were certainly surprised at how it came together,” echoes Jason Vegotsky, chief revenue officer for KushCo Holdings, a major supplier of critical products and services like packaging, labels, vaporizer hardware, extraction gases and more. “It was rather abrupt.”

But the larger issue for the cannabis industry may be the apparent lack of an endgame in the ongoing trade war and the potential questions it creates moving forward.

“With margins already tight, it just gets harder,” says Nik Patel, chief operating officer of California-based Mammoth Distribution. “The longer it lasts, the bigger the hit.”

Packaging problems

Domestic packaging companies cannot match  the price and quality of the Aster Farms Day To Night tins from China, which now cost the company 25% more due to tariffs.

The first shots fired in the current trade war came late in 2018 when President Trump imposed a 10% tariff on Chinese goods. While most businesses were able to absorb that initial hit, the announcement that as of May 10, 2019, the tariffs would increase to 25% caused bigger problems, especially for business that had already placed orders and worked out budgets based on the initial amounts.

Aster Farms, for example, gets a piece of packaging from a manufacturer in China. After placing an order for the company’s Day & Night pre-roll pack, the Trump Administration announced the most recent round of tariffs. The small Lake County cultivator’s shipment was held at the border, and the company was hit with a 25% tax bill in order to have the tins released. But that’s just the start of the potential financial issues for Aster Farms, which has a lead time of up to eight weeks on packaging.

“When we get a timeline back from our manufacturer saying these things are shipping on this date, we make all these other business decisions based on that,” Jacobsen says. “It kicks off a domino effect of all these other decisions that cost money for our company.”

Jacobsen says the company has already found American companies to handle most of the packaging needs it had been buying from China, but the pre-roll tin is not something that can be replicated stateside at the same quality and price. According to Jacobsen, the custom tins use multiple shades of green and getting the color saturation right “has been super tricky.” But because it is a “really important product” for the craft cannabis farm, the company is simply eating the loss from the tariffs on each $2 tin and hoping for a quick resolution.

“It makes margins tighter,” Jacobsen says.

The tariffs on Chinese goods cost KushCo $4 million during the second quarter of 2019, before the jump to the current 25% rate.

Vape cartridges

For distribution companies that order larger quantities of product for multiple clients, the lead time can be months in advance.

For Mammoth Distribution, the tariff increases also came after an order had been made, resulting in millions of dollars of product caught in the system.

“Everything you had already put on order would get hit with tariffs as soon as it arrived at the dock, three to four months later,” Patel says. “That was a big hit.”

Patel says his company’s main imports from China are packaging and vape cartridges, products that the buyers of oil rarely even think about.

“Every single item has a package and has hardware,” he says. “So you’re talking about a 25% increase on cost of goods sold on the components that provide the least amount of value to the consumer.”

At KushCo, the tariffs have meant millions of dollars in additional cost. According to chairman and CEO Nick Kovacevich, the company paid $4 million in tariffs in the second quarter of 2019.

The new 25% tariffs are forcing many in the cannabis industry to look inward for packaging solutions.

“Keep in mind this is before they recently jumped from 10% to 25%,” he says.

KushCo has responded by adding a line item on its bills called a “supplemental tariff fee,” passing the additional cost on to its customers. Kovacevich says KushCo’s customers have thus far been understanding, especially since there are no North American companies that produce the vape cartridges so many in the cannabis industry rely on.

“You don’t have any choices other than ‘buy from China,’” Vegotsky says.

Like Aster Farms, both KushCo and Mammoth have found North American sources for most of the packaging they previously purchased from China, but not the cartridges.

“I don’t know if anybody makes this stuff in America or Mexico or Canada,” Patel says.

Because the cartridges are simply not available in the states, Kovacevich hopes they will qualify for an exclusion to the tariffs, since the point is to encourage American companies to look for domestically made products.

Even if companies were to try and make the cartridges on this side of the Pacific, it would still be difficult to compete with a company like C-Cell, one of the leading cartridge manufacturers in China, which has 10,000 employees, more than 200 engineers and multiple patents, all helping to keep costs down, Kovacevich says.

“How are you going to compete with that in the U.S.?” he asks.

As of May, more than 46% of exclusion requests had been granted, according to Roll Call, a newspaper that focuses on the federal government, but the vaporizer cartridges have not yet been included on that list.

Uncertainty and hope

Without an exclusion, companies affected by the president’s trade war with China will most likely pass on the additional costs to their clients, which could mean customers eventually see a slight increase on products at retail. However, because the cost of each individual cartridge is small compared to the oil inside, most believe producers, processors and distributors will simply eat the loss and hope the tariffs go away soon.

“The whole industry is going to ride this out together,” Vegotsky says.

“Nobody wants to pay millions of dollars to the government for no reason,” Kovacevich adds, estimating the tariffs add about 50 cents to each individual cartridge. “We want to see the trade war go away.”

Patel agrees and says his company is looking at all of its options. But the longer the questions remain, the more difficult it is to make long-term decisions.

“Uncertainty sucks,” says Patel. “As a business you just need to be able to act.”

For smaller businesses like Aster Farms, where margins are already tight, every day they remain in place is a day the company loses money.

“Being a smaller business, it really affects us more heavily than it affects these larger, more well-funded players,” says Aster Farms president Sam Ludwig. “Hopefully the tariffs will go away sooner rather than later, but we have to just start baking this into our margins and just keep trucking and I’m sure there will be light at the other end.”

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