When customers walk into Harvest Off Mission, a cannabis dispensary in San Francisco, it is immediately clear that this place is different. For one, it's beautiful: more boutique gift shop than traditional retail store. Stained oak paneling, adorable light fixtures, bonsai trees, a flood of natural light. But its two biggest innovations are much simpler than that: shopping baskets and stocked shelves.
Really? How could shopping baskets and stocked shelves be distinctive when basically every store in America has them?
Exactly the point. As we established in the first article in this series, the emerging cannabis industry is shedding associations with Cheech & Chong, Bob Marley, and the other touchstones of stoner culture. The industry is clear about what it's not. But does it know what it is?
In this article, we will make the argument that cannabis is a Consumer Packaged Good, highly similar to other CPG categories in grocery stores around the country. In fact, we believe the fundamentals of brand management and sophisticated retailing will eventually dominate the cannabis marketplace in the U.S. This advantages companies like Constellation Brands, The Clorox Company, Unilever, and everyone's favorite monopolistic plot, Amazon. (Note: We use the term CPG as short-hand for a wide range of categories, including those like Beer & Alcohol and Over-the-Counter medicine, which some investors classify separately.)
There are five reasons to believe that CPGs and e-tailers like Amazon will run the table in cannabis.
Reason #1: Equity Investment Demands Scale and Consolidation
The equity value chain is straight-forward: venture capital investors buy early shares, help the company scale, and then sell their shares, at a higher valuation, to private equity firms; PE firms drive the next level of scale, and then sell their shares to strategic acquirers. Those acquirers are almost always CPG companies for consumer products, because CPGs can apply their expertise and scale to generate value above and beyond the purchase price.
In other words, when the first domino falls, it's an indication that CPGs are prepared to enter the market and win. And, in cannabis, the first dominoes have started falling.
Investment firms like Arcview Group and Snoop Dogg's Casa Verde Capital are the early movers, having already invested tens of millions in everything from agribusiness equipment to point-of-sale software to beverage brands. Their portfolios are 100% focused on the cannabis opportunity.
Perhaps more significantly, mainstream investors have also joined the fray. Tiger Global, an investment firm focused broadly on tech and software, led Series A fundraising for Green Bits, a point-of-sale software solution for dispensaries. As The Street put it, Tiger Global signals that there's money to be made by a wide range of institutional investors, not just those focused on cannabis. Its other investments include Netflix and Domino's.
On the other end of the value chain, strategic CPG companies have signaled interest in the space. Constellation Brands, which markets Corona, spent $191 million to buy nearly 10% of the Canadian company Canopy Growth Corporation, which is the #1 marijuana producer in North America, by some estimates.
But Canopy is only #1 because the United States has not ended prohibition, which is now inevitable (see Part 1 for more). Investors are relying on CPG industry veterans to find or create Canopy's domestic equivalent.
Reason #2: People Are Complicated
Achieving scale requires driving trial with more consumers. The first wave of legal cannabis buyers were already in the underground market -- and thus were relatively easy to capture. Studies have shown that early adopters in states like California and Colorado were already often heavy users.
The next wave of consumers will be more complicated, because, well, people are complicated. As we've said in other posts, consumers often say one thing and mean another, or claim behaviors that don't match what they actually do.
This dynamic will be especially fraught with cannabis, because it is surrounded by stigma and moral equivalence. How do you persuade a 69-year-old arthritic grandfather, who spent his entire adult life thinking of marijuana as illicit and shameful, to try it as a solution for pain management? Does the doctor need to tell him? Or does it need to be his wife? Or do you need to call it something else -- like CBD?
CPGs know how to answer those questions, and thus will build more successful businesses.
Let's use the wine industry as an analogy. In the U.S., as in France, the wine industry started out catering to enthusiasts -- or, perhaps more aptly titled, the glass swirlers. With this consumer base in mind, wine makers described their products with belabored, heavily nuanced language and romanticized secondary and tertiary flavor notes like violet -- even though, let's be honest, no one knows how violets taste.
For early adopters, this worked. It created wine's premium tier and established the enduring importance of craft and terroir (i.e., place and soil).
Companies like E. & J. Gallo took a different approach. They approached the market with a CPG lens, starting with a deep understanding of what most consumers want; then they built brand experiences and product profiles to address those needs. This led to decidedly snob-free brands like Barefoot, a wine that glass swirlers won't acknowledge but secretly drink on occasion, making it one of the biggest brands in North America. As it turned out, snob-free wines moved volume and printed money -- and thus, somewhat ironically, generated the cash necessary to buy premium properties like Stagecoach Vineyard (acquired last year for $180 million).
How is this relevant for cannabis?
Consumer empathy, design thinking, and sophisticated marketing will determine winners and losers in the cannabis industry. And those skills predominate in the CPG industry.
Reason #3: Competition Breeds Branding
The first wave of cannabis products have faced very little competition. For newer categories like edibles and vapes, there are sometimes only a few brands in the market.
Three barriers have reduced competition -- all of which have begun to fall.
- Legal Complexity: Crossing state borders with marijuana is either murky or outright illegal. Many manufacturers have chosen to compete in just one state.
- Production Capacity: Robust competition in food & beverage categories is enabled by a broad network of growers and co-manufacturers that can produce just about anything at any level of scale. This infrastructure is still being built for cannabis, as more indoor greenhouses and co-manufacturers raise capital.
- Retailers: To date, dispensaries have not been very discriminating about their assortment -- driven by lack of sophistication, lack of availability, or both.
Once these barriers fall, today's winners will discover what entrepreneurs in CPG have long known: you must build a powerful brand, not just a great product, to keep winning in the long term.
From our early assessment, most cannabis entrepreneurs are unprepared for this reality -- a sentiment echoed by other industry observers. To build a brand, you have to understand how to collect and leverage consumer insights, both qualitative and quantitative. This data is increasingly available, thanks to firms like BDS Analytics, the IRI/Neilsen of cannabis. But does the cannabis industry know how to use them? Time will tell, but there's a good chance that CPG-trained talent will be a requirement.
Reason #4: Shopping Is Science
During our tour of Bay Area dispensaries, we were amazed by the number of mediocre shopping environments. Intimidating security guards at the front door. Bullet proof glass. Limited assortment. Very little signage or merchandising or anything that explained product benefits, forcing you to join long queues for a sales person. Only the most motivated consumer would persist.
Some of this is driven by unique industry dynamics. As long as cannabis is a federally controlled substance, banks are not allowed to deposit cannabis-related earnings. This means that dispensaries are sitting on large amounts of cash or cash-equivalents, which leads to strict security protocols. In addition, medical marijuana laws often require consumer registration, which adds another layer of hassle to the shopping experience.
However, even within these constraints, many dispensaries make things even worse. They overlook something that CPGs, retailers, and e-tailers deeply understand: shopping is psychology. Some cannabis consumers need to browse without being "seen". Others need hand holding. Still others want to get in and out. And then, in a growing number of instances, some don't want to leave the house at all. In fact, e-commerce companies like Eaze are betting that online purchases and home delivery will represent a large portion of cannabis sales. (For the record, we think they're right.)
Therefore, to win, dispensaries must create an environment that appeals to multiple consumer needs or carefully caters to one. Harvest Off Mission in San Francisco exemplifies how to do this well. Salespeople were light touch. Shelves were stocked with inventory and peppered with informative signage. They had shopping baskets. All of it was designed to facilitate browsing and independence.
There is one national player that understands this landscape better than anyone else: Amazon.
Along with its new partner Whole Foods Market, Amazon has mastered both ends of the retailing spectrum -- from tech-enabled home delivery to shopper-friendly brick-and-mortar. It is easy to imagine a world in which those two capabilities, combined with Jeff Bezos' access to capital and willingness to take risk, give Amazon the majority of the cannabis retail market.
So What's The Takeaway?
For cannabis entrepreneurs: Do an honest self-assessment: Are you positioned to win in the long-term, as competition ramps up? If not, strengthen your team with CPG talent, either as consultants or employees. Your success may depend on it.
For CPG leaders: If you're not looking at cannabis-related innovation, you should be. It will be relevant to a broad set of categories, from health & wellness to personal care to food, as we spell out in Part 1.
For CPG talent: If you're looking for the next opportunity, pay closer attention when a cannabis recruiter pings you on LinkedIn. The upside may surprise you.