What is vertical integration?
Vertical integration is an economic term used in business models to describe the systematic affairs of a company. These affairs refer to whether the stages of a company’s supply chain operations are directly owned by that respective company or not. In other words, vertical integration means the entirety of a business’s supply chain is integrated, owned, and operated by that company. Additionally, each step and stage of its supply chain is directed by the business.
For example, Tesla is an extremely successful vertically integrated company. Tesla has domestically controlled the manufacturing and distribution of its product since the dawn of its first vehicle back in 2008. Elon Musk, founder and CEO of Tesla, has even gone as far as to say that Tesla is “absurdly vertically integrated compared to other auto companies”. This is especially impressive due to their ability to eliminate the dependence on hardware and software engineering from other companies.
Although Tesla’s undoubted success lies within a vertically integrated business model, Elon Musk and his team at Tesla were by no means the first to implement this business model. In fact, vertical integration was first used by Andrew Carnegie in his steel business over a century ago. Additionally, Henry Ford and other car companies also decided to take full control of their supply chain back around the same time. These types of businesses ultimately sought to minimize costs by integrating the production of their products, but in turn, they ended up paving the way for modern-day companies.
How is vertical integration applicable in the cannabis industry?
When it comes to vertically integrated cannabis companies, operations are able to run efficiently, ensuring a streamlined seed-to-sale process. Meaning, the entire lifecycle of cannabis plants – from its inception as sprouting seeds, all the way to its culmination as a product purchased by a customer at a dispensary – is integrated into cannabis companies’ supply chain. Not only does this process boost performance and productivity in the cannabis sector, but it also allows for tighter control and regulations, as well as reduced costs.
Cannabis companies that function in this manner generally follow the same four stages:
- Stage 1 – Cultivation Stage
The cultivation stage refers to everything growth-related for a cannabis plant – from seed to maturity, to harvest. The stages of cannabis growth can be further broken down, each varying in both its level of complexity and environmental and nutritional needs. Once cannabis plants have reached full maturity, or after roughly 3-8 months, cultivation technicians carefully trim the plants in preparation for stage 2.
- Stage 2 – Lab and Extraction Stage
Stage 2 refers to the actual practice of taking a mature cannabis plant and extracting its highly sought after chemical constituents, more commonly known as cannabinoids. Prior to being extracted, cannabis plants must be dried, either through air-drying (aka hang-drying), oven-drying, or freeze-drying. The drying stage is vital in preventing microorganism growth/contamination, as well as maintaining potency, taste, medicinal properties, and efficacy. Solvent extraction is the most common method for cannabis extraction; however, solventless and hydrodynamic extraction are becoming increasingly more popular due to their high yield and more natural approach.
- Stage 3 – Manufacturing Stage
All the extracted cannabis material made in Stage 2 is now crafted into consumer products, ranging from gummies to vapes to lotions to patches to tinctures. Post-processing refinement and infusion of extract with other ingredients happen during this stage. As for the plant material that is simply sold as flower and nothing else, it is weighed and labeled during this stage.
- * Third-party laboratory testing stage
This supply chain stage is NOT owned or operated by a cannabis retail company. Rather, third-party testing by laboratories, such as Modern Canna, provides an unbiased analysis of cannabis products. In this stage, products must pass regulatory limits for various contaminants, such as pesticides, microbials, heavy metals, mycotoxins, and residual solvents. Products are also tested for potency, terpenes, moisture, and nutrient levels. Further, more in-depth testing, such as genetic or stability testing, can be performed upon request.
- Stage 4 – Retail Stage
The final stage in any vertically integrated cannabis company is retail. Cannabis products sold by retailers must be labeled in a way that complies with state and federal laws before being placed on the shelves. Florida requires all cannabis and cannabis products to be packaged in compliance with the U.S. Poison Prevention Packaging Act of 1970. According to Florida state law, medical marijuana treatment centers, aka MMTCs, must insert information on the specific product dispensed relating to clinical pharmacology, indications and use, dosage and administration, dosage forms and strengths, contraindications, warning and precautions, and adverse reactions.
Why is vertical integration in the cannabis industry so prevalent?
Overall, vertically integrated cannabis companies are able to:
- Increase profitability
- Improve efficiencies
- Control product supply chain
- Reduce costs for consumers
- Direct link to market
- Take advantage of the competition
- No reliance on suppliers
- Maintain quality control
As you can see, there’s a commendable list of pros that can come with vertical integration. In addition to appealing to properly licensed cannabis companies, it can also enhance the overall experience for customers as well. When vertical integration is implemented properly, consumers, such as medical marijuana patients, typically receive cheaper, fresher, and higher-quality products.
Enough of the pros – are there any cons to vertically integrated cannabis companies?
Yes! Both pros and cons simultaneously exist within just about every type of business model.
The disadvantages of vertical integration include:
- High capital requirements
- Reduced flexibility
- Unforeseen labor issues
- Risk of organizational inefficiencies
- Barriers to market entry
- Capacity-balancing problems
- Forces businesses to operate within an economy of scale
Usually, business owners decide which model they want to operate upon pretty early on. However, in the cannabis sector, things are a little bit different.
Banning vs. mandating – why some states love vertical integration and others don’t
Since marijuana is still illegal on the federal level, each state goes about its cannabis legalization and operations differently.
From cannabis growers, to manufacturers, to retailers, and even legislators – there’s a wide array of mixed emotions surrounding vertical integration in cannabis markets. It affects each stage and sector of the market differently, which is why each state is choosing to go about it differently.
From a health and safety perspective, mandating vertically integrated cannabis markets helps ensure the quality of products. That’s why vertical integration mandates can mainly be found in states that have legalized medical marijuana.
From a small business perspective, mandating vertically integrated cannabis markets can be seen as a detrimental move. In other words, smaller businesses could see this as a way for larger corporations to monopolize the cannabis market.
From a legislative perspective, mandating vertically integrated cannabis markets could help slow the growth in the initial stages, which could benefit early entrants into the cannabis space.
A majority of states that operate vertically require separate licenses for dispensaries to be able to produce and sell their own product. Most commonly, the licenses offered are for selling, cultivating, and processing marijuana. Some states also require additional licenses, such as transportation licenses. For example, Illinois requires 5 different licenses.
On the other hand, for New Hampshire and Delaware, where only medical cannabis is legal, dispensaries are not-for-profit, meaning that all the money earned goes right back into the business, rather than to the owner(s). In this instance, it is also encouraged to cultivate their own products.
States like Florida, Minnesota, and Montana have all-encompassing licenses. The laws in states with all-encompassing licenses usually mandate physical boundaries between growing spots and sales areas.
There has been some controversy with licensing, mainly pertaining to the capacity or cap. The issue of license caps has unveiled a major inclusivity issue within the multibillion-dollar cannabis industry. Oftentimes, minority and entrepreneurial applicants must compete against multistate operators (MSO’s) who are much better positioned to afford pricey business permits in a limited-license market.
No slowing down now…
Florida is home to not only Modern Canna’s laboratory operations but also a $1 billion cannabis market. This past fall Forbes described Florida as, “the country’s largest medical cannabis market”.
This past March, Florida’s Department of Health opened applications for one singular license, dubbed the Pigford Black Farmer License (BFL). The application fee starts at a whopping $146,000 and is strictly for Black farmers in the Pigford v. Glickman case that run their farming operations under vertical integration. Pigford v. Glickman was a class action lawsuit between the U.S. Department of Agriculture and Black farmers from the year 1981 to 1996.
Florida’s cannabis market currently has 22 licensed MMTCs that cater to the 700,000+ registered medical marijuana patients in the state. Several of Florida’s medical marijuana vertical operators are also multistate operators.
In addition to the Pigford License, Florida’s Office of Medical Marijuana Use (OMMU) plans to issue several new licenses in 2022/2023.
Florida’s cannabis industry is on track to top $6 billion by the year 2030. With that being said, it appears that there is no slowing down for the sunshine state, and vertical integration might be here to stay.