August 22, 2018 by By Kevin Lea
For the first time in more than 90 years, a completely new industry is being created in Canada by virtue of government legislation: recreational cannabis. Canada will be just the second country in the world to legalize cannabis for recreational use (the first was Uruguay in 2013), and the first of the leading G7 powers. Early estimates from Deloitte predict that the total medicinal and recreational cannabis market in Canada will exceed $7.3 billion in sales in the first 12 months after legalization, with sales to steadily increase in the years after that.
With this much money being diverted from the black market, and with numerous opportunities for tourism and global export of cannabis products—all within a new legalized, taxed and regulated framework—it is no surprise that a variety of stakeholders want to earn their piece of the pie. Foremost among these are the federal and provincial/territorial governments, who will be charging substantial excise taxes on cannabis products. A number of provinces are taking things a step further, and also choosing to act as wholesaler and retailer. Every province is taking a different approach (see Table 1).
The actual growth of cannabis, and further processing or manufacturing of cannabis products, will continue to be performed by private Licensed Producers (LPs) overseen by Health Canada, with these LPs shipping their product to government distributors, private retailers or medical patients as applicable.
Although the government has certainly carved out a significant role in the cannabis supply chain, especially in central and eastern Canada, there exists substantial opportunity for private enterprise in cultivation/production nationwide and in retail within British Columbia, Alberta and Saskatchewan. Given the number of businesses likely opening under the private retail frameworks in these provinces, it is important for insurance brokers operating in these provinces to be aware of the challenges facing these new operations.
Obtaining a licence to sell
Since the cannabis distribution models in each province tend to fairly closely model the existing alcohol distribution systems already in place, we can use alcohol licensing counts to help predict the potential market size for private cannabis retailers.
Given that initial estimates from the Alberta government predict the issuance of approximately 250 retail cannabis licences within the first year, and that the Saskatchewan government has chosen to issue just 51 licences province-wide, there will be a substantial gap between the number of cannabis stores and the number of liquor stores (over 2,000) in the market.
However, that is likely to change following legalization, since the demand for cannabis licences remains very high. Saskatchewan issued their licences through a lottery process, which received approximately 1,350 submissions for the 51 licences available. Alberta is not placing a cap on the number of licences issued, but all licensees must comply with provincial requirements, including not being located within 100 metres of a school or provincial health care facility, and also needing municipal approval (which may have stricter requirements). At the end of June 2018, Alberta had already received more than 730 applications for retail cannabis licences, which suggests that the number of first-year approvals may be above previous government estimates. (Estimates for British Columbia are not yet available as the application process for private retailers in that province was just getting underway at the time this article was written.)
Private cannabis retailers in Alberta and B.C. also have another major obstacle to overcome before a licence can be issued: the requirement that the proposed licensee must have an owned location or a signed lease prior to beginning the application process. This means the prospective retailer must not only start paying rent months before the store can even open, but it also forces them to run the risk that, should their licence not be approved, they are on the hook for a year or more in rent for a location that is not legally allowed to operate. Compounding this risk is the fact that most businesses will also begin to prepare the retail space before the licence is approved, adding to the expense.
The requirements for a cannabis store in Alberta are strict, and they are expected to be similar in British Columbia. Retailers need to have cameras, alarm systems, anti-theft protections on windows and doors, separate display, shipping and sales rooms, and limited signage, among numerous other requirements. On top of these, all retailers must have either a safe or a secure room (effectively a vault) that all product must be stored in overnight. Further, no sampling of product is allowed on site, and minors are not allowed to enter the store (even if accompanied by their parents). In contrast, liquor stores legally require none of these measures; minors are allowed to enter (but not buy anything, of course) and many liquor stores offer free samples and run tasting events.
Adhering to federal regulations
Beyond the restrictions imposed by provincial cannabis control boards, until federal bill C-45 (the Cannabis Act) received Royal Assent in mid-June 2018, there was significant uncertainty at the federal level not only with the legalization date, but with numerous other factors, including the extent of promotional materials and advertising, the types of products available for sale, pricing and other key business concerns. Although the Senate agreed to remove some of their requested advertising and promotional restrictions in its final reading of the bill, the overall legislation is still substantially more strict than the laws passed in most of the U.S. states that have legalized recreational cannabis.
Perhaps the most striking example of this is that pre-manufactured cannabis edibles (such as chocolate, cookies or brownies) are prohibited under the current rules. Although consumers are free to cook up a batch of homemade treats, it is much more difficult to control THC and CBD levels in homemade products than in commercially produced items. This can lead to people getting far more intoxicated than they intended, which defeats the purpose of having a properly regulated and controlled market with clearly labelled products.
There is also a health consideration, as many people prefer to avoid smoking (both cigarettes and cannabis) due to the possibility of lung damage and because of the smell, in addition to public and private indoor smoking bans. Edibles allow consumers to get the recreational high of THC and the health benefits of CBDs in a much more accurately controlled dose without the negative side effects of smoking. In fact, this shift in consumer behaviour is readily apparent in U.S. states with legal “flower” (dried cannabis leaves and buds) and legal edibles.
According to BDS Analytics, edibles and concentrates rapidly took market share away from flower products in the state of Oregon during the first two years following legalization. In fact, the combined edibles and concentrates market share now slightly exceeds that of flower, and this share is likely to continue to grow as consumers recognize the benefits of moving away from smoking as a consumption method.
Because edibles will be prohibited when Canada legalizes cannabis (although the government has committed to making edibles legal within 12 months), private retailers will suffer from reduced sales. Further, U.S. market research has shown that edibles typically command higher margins than dried cannabis or pre-rolled joints, so it also means that retailers are missing out on a valuable profit stream from these products.
If Oregon is any indication, once edibles are legalized, they both start to take up market share as well as help drive overall cannabis sales to new levels. This is a great opportunity for retailers, but they need to be prepared for the rapid market shift. If the retailer is sitting on unsold flower when the market starts to shift, it could lead to significant losses. This is compounded by the fact that dried cannabis is a perishable product with a shelf life of approximately 12-18 months (in contrast to years or even decades for wine and hard liquor).
Further compounding the market shift issue is the fact that federal regulations require all retail cannabis to be packaged in plain packaging with minimal branding and significant health warnings. This means that consumers will not have the colourful labelling often seen on alcohol bottles to help them distinguish and choose a product. Should a certain producer’s product fail to gain traction or face poor reviews, it could languish on the shelf until it expires. This results in not only a financial loss from having to throw it out, but also ties up the retailer’s cash flow with unsold inventory.
Understanding a new market
Outside of the regulatory and product-specific risk, there is another major challenge facing these new businesses: the fact that the other entities they need to support them (from lawyers to banks to insurance brokers) often know little about cannabis and even less about the myriad regulations surrounding the new industry. This means cannabis retailers are often not receiving the same quality of advice and products that other retail businesses might receive, which could imperil their operations. In contrast to the other issues, this challenge has a relatively straightforward solution. There are insurance brokers, bankers and lawyers who have dedicated themselves to understanding the cannabis industry in depth, and the cannabis entrepreneurs who seek out these educated professionals will get much better support and advice than those who use someone without appropriate experience.
There is significant opportunity for private cannabis retailers in the provinces that allow these businesses to set up shop. However, this opportunity is bundled with asubstantial amount of regulatory, market and general business risk that needs to be assessed before startup, and continuously during operations. The businesses that surround themselves with the right professionals will get the right support to help them navigate these challenges, and be able to focus on growing their new operations and helping Canadians enjoy our soon-to-be legal cannabis marketplace.
Kevin Lea is president and co-founder of Fuse Insurance Ltd., Western Canada’s first online commercial insurance brokerage. A graduate of the University of Calgary’s Risk Management & Insurance program, he also holds his CIP, CAIB and CRM designations. Kevin has won numerous industry awards, including being recognized as one of CITB’s Top 10 Under 40 in 2017. He currently serves as vice-president of Alberta’s Professional Young Insurance Brokers Association.
Copyright © 2018 Transcontinental Media G.P. This article first appeared in the August edition of Canadian Insurance Top Broker magazine
This story was originally published by Canadian Insurance Top Broker.