Many leading cannabis companies, particularly US-based multi-state operators (“MSO’s”), actively promote the extent to which they are vertically integrated.
The question is, why does anyone care?
Or, perhaps shouldn’t their vertical integration even be a cause to worry for investors?
After all, the rest of the business world isn’t vertically integrated.
As an example, consider that if you are like most denizens of modern society, your day probably started with checking your smartphone. The world’s largest smartphone provider, Apple, outsources the production of its iPhone to low-cost Asian factories. Other smartphone companies, and tech hardware makers in general, do the same. Apple’s massive accumulation of investor wealth has been fueled by technical innovation, design and branding, activities which have the potential to generate spectacular margins if done well. Apple might be larger, but almost certainly poorer, if it decided to become a high volume, low margin manufacturer of consumer electronics.
Same with Nike. They design and someone else makes their gear.
Starbucks sells a of coffee, but there doesn’t seem to be any compelling reason for them to become a coffee producer.
These companies illustrate that specialization and global supply chains are the beating heart of the modern economy. It’s hard to be good at one thing. Being good at a lot of things is even harder. And the one thing companies should strive to be skillful at is what makes them special, proprietary or unique, such as brand equity or technology.
The one thing companies should strive to be skillful at is what makes them special, proprietary or unique, such as brand equity or technology.
Successful, innovative companies do not see any particular value in tying up their capital in low-margin businesses simply to generate additional revenues.
Of course, cannabis today does not enjoy the luxury of a global supply chain and is subject to operational limitations few other industries have to deal with. While the state of the legal industry today is light years ahead of a few years ago, regulations still hamstring the market. So vertical integration is a way to get larger, faster.
But, since growing cannabis, processing the flower into finished product, transporting it to market, developing brands and operating retail stores require vastly different skills, it’s likely that aiming for large size alone may be a burden that slows companies down and forces managements to spread themselves overly thin.
Cannabis companies collectively are young and have relied on rapid revenue growth to instill investor confidence. But a lot of that growth has come in the commodity side of the business, which is inherently low margin. As market sentiment in the cannabis sector shifts, and investors begin to look past revenues and focus on profits, the idea of being big as a validation of a business plan may become quickly outdated.
Maybe being a little less vertical will come into fashion as a result. Size matters. But companies need to make sure that extra weight gets added in the form of muscle. Stronger, not heavier.
A little flatter on top may do wonders for the bottom line.
Ed Harris is the CEO and co-founder of Pacific Growth Capital, which operates the Spark® Deal Room. Originally from New York, Ed now lives in Seattle with his family, where he enjoys the scenic beauty and slower pace of life that the Pacific Northwest offers. He does, however, forbid his children to root for any professional football team other than the NY Giants, and misses the pizza.