As flower prices crash, margins remain higher on concentrates and edibles
As state-legalized markets have exploded over the last decade both in the United States and abroad, one predictable trend has proven inescapable: Prices boom at first when supplies are low, then they bust when inevitable oversupplies hit.
Eventually, market prices stabilize, albeit to a much lower level than most people first expect. If you think the wholesale price of flower in any given market won’t drop below $1 a gram, think again.
A second, equally predictable trend occurs in these same new cannabis markets, wherein most investors and managers seem myopically focused on getting their grow facilities up and running, while almost completely ignoring the processing lab. Many allocate their entire startup budget to growing, with nothing left over for processing.
While this approach might make sense when a new market commands $4,000 to $7,000 per pound for flower, it can be a huge mistake when one considers that flower prices are almost guaranteed to erode to below the cost of production for all but the largest and most efficient producers. Plus, as markets mature, approximately half of the products sold to consumers are in the form of concentrates or edibles.
But smart investors don’t fear this precipitous drop; they plan for it. While flower margins crash, concentrate margins typically stay 30-50% higher than flower, and margins on infused products can be up to 200% higher.
This begs the question from a business standpoint, why aren’t cannabis operations more focused on processing when it’s much more profitable than growing?
The first answer is often that one needs biomass before it can be processed. On the surface that makes sense, but this thinking ignores two huge realities of the cannabis industry. A deeper dive uncovers the fact it takes the average licensee about two years to get permits and finish a buildout. In that time, existing medical grows typically flip to recreational more quickly, and at least one outdoor harvest hits. By the time that new indoor cultivator has its first harvest, $7 grams are now 70 cents and suddenly there’s a shortage of processors. To be fair, this same boom-and-bust cycle hits the processors too, only it takes two more years to reach them, which is often about the same time their market stabilizes. Most importantly, processing margins tend to remain higher as time goes on, assuming the operation has invested in the efficiencies needed to compete.
The other hard reality often overlooked is that only about 15% of a plant is sellable flower, leaving growers asking what to do with the other 85% of it. For many, the answer is store it and watch it degrade, since there are never enough processors to run it in emerging markets.
With most any commodity, including coffee, corn and sugar, farmers typically make 10 cents for every dollar a processor makes, and like many cannabis entrepreneurs, they soon find themselves struggling to earn meek subsistence livings while processors rake in massive fortunes. Processors also weather market fluctuations more easily and are not at risk of going under just because of one failed crop. Laws generally stipulate that flower that fails testing needs to be destroyed, unless it’s converted to oil and remediated, in which case only the processor profits.
Like flower, margins always depend on the specific market. One liter of BHO with an average purity of 80% in one state may sell for $5,000 ($5 a gram), but in other markets, that same liter can be worth almost 10 times that.
To compare margins between cultivation and processing, let’s assume it costs an indoor grower 70 cents to grow one gram of flower. In many mature markets, the wholesale value of flower is about $1 per gram, which would earn that grower a 30% pre-tax profit.
It takes a processor about 15 pounds of trim to get one liter of dabable concentrate, so at $50 per pound of 15% THC trim, that’s $750 for biomass to get one liter of concentrate. Add in about $50 per liter in operating costs to run the extraction machinery and you’re looking at $800 all-in per liter in this scenario.
In 2021, Marijuana Business Daily reported the average wholesale price of concentrate was $7,000 to $9,000 per liter ($7 to $9 per gram), though some saturated markets are trending toward $2,500 per liter — still a substantially better margin than flower.
With edibles, it’s even more dramatic, considering there are 1 million milligrams in a liter, and many states limit edibles to 10 milligrams of THC per dose. In many markets, edibles sell for $2 per dose or more wholesale.
After more than a decade of evidence, it is clear that processing remains profitable as cultivation sees declining margins, and this historic trend matches what most commodities experience in general. Knowing all this, one can see the value of vertical integration, but the question remains: Why are licensees still choosing to ignore or delay their processing lab buildout? Maybe it’s because processing is perceived as being more technical in nature, which is true to a degree, though with its technical nature comes the opportunity to produce trade secrets and intellectual property that investors value strongly. Maybe the impression is that processing is more capital-intensive?
No, the more likely reason licensees fail to plan for processing is much simpler: They just don’t know any better, yet.
Steve Fuhr is the business development coordinator at SciPhy Systems. He has spent the last decade in the cannabis industry, involved in all phases including growing, processing and infusing edibles. He can be reached at SteveFuhr@SciPhySystem.com.