The True Story Of The Great Marijuana Crash Of 2011

[7greeneyes]

url: hMPp://www.businessinsider.com/the-great-marijuana-crash-of-2011-2013-9

The True Story Of The Great Marijuana Crash Of 2011​

Buying marijuana in Denver is a downright pleasant experience.

Customers wait in a well-appointed waiting room. There's a variety of reading material — feel free to choose between the gardening magazine and the Cannabible on the coffee table — and plenty of information about the product.

When their names are called, they will follow an attendant through an atrium where they can buy t-shirts or smoking paraphernalia, and into a quaint shop where they can peruse the wares.

There, they will find a wide array of aromatic marijuana flowers in glass jars, pot-infused products — mints, beverages, or something to satisfy the sweet tooth — as well as pre-rolled joints and servings of cannabis concentrates.

Customers are rung up on a computerized point of sale system. They get a receipt — a receipt! — after paying for their marijuana.

They are free to walk out to their cars, drive their marijuana home, and smoke it.

It's a remarkably clean system. It doesn't feel like a violation of Title II of the Comprehensive Drug Abuse Prevention and Control Act of 1970, the federal law that governs controlled substances, even though it is. It's a safe, stable, professional environment.

It's remarkable that only two years ago, the whole system almost came crashing down during the most difficult economic event the infant cannabis industry has ever faced: The Great Marijuana Price Crash Of 2011.

How did it all come about?

The story of the marijuana market — a business that thrived on the street for decades before developing the market sophistication to lead to a commodity crash in brick-and-mortar stores — is one of the most interesting economic stories of our lifetimes.

The Colorado marijuana industry has accomplished something not seen in this nation since the passage of the 21st Amendment.

Colorado legalized marijuana for recreational use in late 2012. Beginning next year, anyone with an I.D. can waltz into a marijuana dispensary, put $50 on the counter, and announce to the clerk that he'd like one eighth of an ounce of marijuana. And he'll get it, without any interference from law enforcement. The market is stable.

The Colorado marijuana industry — which is responsible for thousands of new jobs, and is projected to raise $130 million in taxes for the state next year alone — has accomplished something not seen in this nation since the passage of the 21st Amendment.

It has taken an illegal product and legitimized it in the eyes of the government. It has made a notoriously sketchy transaction less of a hassle than buying Sudafed. What’s more, it has built a thriving economy after overcoming wild price fluctuations and crashes, stern government regulation, and absurd banking restrictions.

The last time something similar happened, 96.5% of the United States population hadn’t even been born yet.

According to media customs it is evidently mandatory to include this photo or one like it in any story about marijuana.

What’s going on in Colorado is an outstanding case study in what happens when a black market becomes a legal one, and it’s something we probably won’t see again in any of our lifetimes.

And fortunately for observers, the market transition in Colorado is happening in relatively slow motion, making it easy to follow and learn from.

Still, when the media covers marijuana, the story is typically accompanied by a photograph of a man smoking an absurdly large joint. But the legalization of the marijuana market in Colorado is actually one of the more fascinating economic stories to unfold in the U.S. in a long time.

LAYING THE GROUNDWORK

In 2000, Colorado voters approved Amendment 20, legalizing medical marijuana for patients and people they designated as their caregivers.

Patients or caregivers could possess no more than 2 ounces of marijuana and not more than six marijuana plants, up to three of which could be mature and flowering at a given time.

The earliest incarnation of the marijuana dispensary quickly sprung up. Certain individuals or ad-hoc businesses began providing marijuana to many patients.

To try to kill the commercialization of legal marijuana, the Colorado Department of Public Health limited the number of patients each “dispensary” could serve to five. After a lawsuit from advocacy group Sensible Colorado, this policy ended in 2007. When the Board of Health rejected a new, more formal policy attempting to codify the five-patient limit in 2009, the dispensary model was given implicit approval.

By 2010, marijuana advocates and the Colorado legislature saw that they would soon have to begin seriously regulating the marijuana market, as the 2000 amendment didn’t plan for a commercial marijuana economy.

Legislators passed the Colorado Medical Marijuana Code, which established a rigorous regulatory system for the medical marijuana market.

It designated four types of state licenses — dispensary, growery, marijuana-infused product manufacturer, and laboratory — and laid out the enforcement bureau (The state Department of Revenue) production limitations (six plants per patient on the rolls for a dispensary) and vertical integration, which required store-front dispensaries to grow 70% of the product they sell. The Medical Marijuana Code also allowed municipalities to ban marijuana.

The passage of the Code kickstarted the industry's transition. Delivery services transitioned into store-front dispensaries. Growers and sellers merged their businesses in order to abide by the vertical integration laws. New companies scrambled to get patients on their rolls in order to grow product. A year later, in 2011, the assembly passed an update which required businesses to register their groweries with the enforcement bureau.

Because the market was designed to be heavily controlled, Coloradans have been mostly exempt from interference from federal law enforcement, unlike California — a state that let every municipality make its own marijuana controls — and which has been repeatedly hit by raids.
This also means that the Colorado medical marijuana market was able to develop a sophistication and professionalism unlike any other in America.

But trading Phish t-shirts for business casual changed the market in ways that nobody expected. The range of choice and quality caused a diversification of product. There were price fluctuations, ill-fated marriages, terrible business decisions, and more between 2010 and today.

 

[7greeneyes]

ILL-FATED MARRIAGES

In addition to establishing a set of regulations, the passage of the Colorado Medical Marijuana Code of 2010 fundamentally changed the structure of the industry.

Before 2010, marijuana was produced by "basement growers," or people who grew marijuana informally on behalf of patients and sold it either directly or to a delivery service or other provider.

The Medical Marijuana Code mandated that all people who sell marijuana grow 70% of their product, essentially requiring all growers to link up with a brick-and-mortar, licensed dispensary.

This meant that marijuana growers — people who were familiar with the plant, and often had a longstanding, personal relationship with marijuana — started connecting with capital-flush entrepreneurs interested in setting up a retail operation. One side had the expertise, the other had the cash.

Needless to say, the merging of the two sides did not always go smoothly.

“You had basement growers along with some guy who had money,” and each side viewed the other with a degree of skepticism, said Ryan Cook, the general manager of The Clinic, a popular chain of marijuana dispensaries, and an expert on the business side of marijuana sales.

Often, the grower and the retail entrepreneur viewed their entities as entirely different organizations. This would prove to be an issue when it came to pricing the product.
The basement growers entered the formal industry assuming that the price of marijuana would hold steady with the black market price. The initial offer they made to the retail entrepreneurs — $4,000 worth of marijuana for a $3,500 wholesale price — was based on that assumption.

The risk of growing marijuana in a basement when it wasn't legal was priced into that high wholesale cost: The idea was that when the industry transitioned to the legal medical market, the portion of the price that went to cover the risk would instead cover new expenditures like rents on warehouses and retail facilities.

But those initial price estimates did not hold, and that's when people began to panic.

THE GREAT MARIJUANA PRICE CRASH

For growers, expanding from a small basement operation to an industrial-level growery often led to production issues, and many growers found themselves in over their heads in terms of the volume they needed to produce.

To make matters worse, the summer of 2011 saw record heat across the country, and heat can wreak havoc on cannabis quality and yield.

“You had all these people racing to grow a product,” said Cook. “Some were growing it good, some were growing it really, really bad. Everyone had to start moving that product."

As a result, many inexperienced growers saw that they had an inferior product that couldn't command what had been the market price.

Growers whose product wasn't up to snuff went into crisis mode. They were dealing with long lead times, since it takes about six months to harvest a marijuana plant. And they had bills — electricity, rent, cost of goods sold — they had put off, promising landlords and creditors that after the harvest they'd have enough to pay them back and then some.

When they couldn't move the product off the shelves, the growers slashed the wholesale price, sometimes as low as $2,000 per pound from $3,500 per pound.

As a result, the retail side started cutting the sale price of an eighth of an ounce of marijuana to as low as $25, half of what they originally planned.

It also didn't help that some dispensaries offered outrageous incentives in order to attract customers.

Dispensaries had to have patients on their books in order to grow marijuana, and the more patients they had, the more plants they could grow.

To get the ball rolling, businesses needed to sign on a critical mass of people, said Dan Williams, the owner of Canna Security America, a security company that specializes in marijuana dispensaries and who has watched the industry transform. As a result, many of them offered outstandingly low introductory rates for marijuana for people who signed on.

“It was great because they got a whole bunch of new patients,” Williams said. “But what they didn’t realize was since everyone was doing that, they were lowering the cost of the entire market. They were cutting everybody under.”

As a result, customers — who could suddenly "comparison shop" among marijuana vendors for the first time — started patronizing the dispensaries that sold cut-rate cannabis. For many, the low prices were simply more attractive than higher-priced, higher-quality product.

As the retailers — who were often marijuana novices — understood it, pot was pot. Many didn't realize that there were differing qualities of cannabis. They wanted all growers to bring wholesale cost in line with what the bad growers were charging.

Growers who had maintained quality and held the wholesale price at $3,500 per pound found themselves under pressure from their retail partners to take a price cut.

When growers held the line, retailers threatened to dissolve the partnership — taking their patient rolls with them — to merge with one of those $2,000 wholesale growers. The growers also threatened to walk, which meant that the retailer would lose its license to sell.

Cook explained: “The retailers are saying to the growers, ‘Hey you were so nice to get me $3,500 a pound, but I can get it for $2,000 over here. I’m no longer going to buy this, I’m going to force you to give this to me at $2,000 per pound.’”

Since some of these businesses were formed as a result of the M&A version of a shotgun wedding, many of them broke up.

A MARKET SPLIT

The businesses that remained had a decision to make when it came to price. The market split into two.

Some portions of the market decided to hold the price at $3,500-per-pound wholesale, or around $50 retail for an eighth of an ounce.

Others said they would sell across-the-board $25 eighths and try to make the price cut back on volume.

If I drop my prices to $25 and take 50% more market share than I had before, did I really help myself?”
Those companies that held the $50 line by keeping quality high have done better than the ones that pursued volume, thanks to the unique aspects of the production of marijuana.

Marijuana has a six-month production lead time. And production is limited by two factors: space and light.

“The problem is that you can't just go back to your manufacturing facility and say, ‘Guys, we need more, turn up the speed on the conveyor belts,’" said Cook. "It doesn't work like that.”

Businesses that wanted to make it back on volume couldn't just jam more plants into their groweries. They had to build whole new warehouses with lights, which could cost between $500,000 and $1 million right out of pocket.

That kind of growth is just unsustainable long-term.

“So once I hit my capacity," said Cook, "if I drop my prices to $25 and take 50% more market share than I had before, did I really help myself?”

 

[7greeneyes]

THE UNSAVORY ELEMENT

Companies that make profit with a high-volume, low-price model are unsustainable for another reason.
They will often find themselves with a production surplus, which for a marijuana company can be a very dangerous thing.

In a healthy market, international marijuana arbitrage — buying legal pot in Colorado to sell on the black market in, say, New Jersey — simply does not make economic sense, because the wholesale prices are largely in line with black market prices.

It wouldn't be logical for unsavory elements to drive out to Colorado, buy a bunch of marijuana at $3,500 per pound and resell it in New Jersey for $4,000 a pound. There’s an insufficient profit margin to accept that risk.

But when desperate businesses had to unload $2,000 pounds of marijuana or risk losing everything, the unsavory element did emerge.

Businesses that were stuck with marijuana they couldn't sell in the Colorado market, despite owing business debts, were highly susceptible to black market offers.

“All of a sudden, some guy in Iowa calls you and says, ‘Hey listen, you know what, I'll give you $5,000 a pound.’ And they're like, ‘Holy sh**!’ you know?” said Cook.

The marijuana price crash of 2011, then, wasn't just an an isolated economic incident. It was an existential threat for an industry that sold itself to voters as a safe business that wouldn't fund the interstate black market.

“All of a sudden, some guy in Iowa calls you and says, hey listen, you know what, I'll give you $5000 a pound. And they're like, holy sh**, you know?”
In the end, many of the places that tried to survive by volume alone went under. The market wised up. Some couldn’t sustain the production growth. Some couldn’t survive in a market with high competition and very low margins.

Others tried to unload their product illegally, and they ended up with doors no longer attached to their frames and federal agents un-cooking their books.

Others, though, like Cook’s The Clinic, emerged from the crash stronger than ever.

“We understood very quickly that it was better for us to operate a legitimate business and grow good, quality medicine and make a business we could be proud of, you know?” he said. “And if we did that we knew we could be successful in the industry.”

EMERGING STRONGER THAN EVER

Well, right this instant Denver is in the midst of another moment of economic intrigue.

There’s a new breed of investor coming to marijuana. Dan Williams, the man behind Canna Security, has already received an infusion of capital from the Arc View investment group, a consortium of investors who focus on the ancillary businesses of the emerging marijuana industry.
Now that marijuana is on the map, people with cash are ready to dive in.

Arc View in particular is interested in businesses like Williams’, which are on the sidelines — i.e., not in direct violation of the laws of the United States federal government — but also are tapping into the robustly growing marijuana market, with the ability to scale nationwide if and when serious marijuana legalization moves beyond the Rockies.

Who are these new investors in marijuana infrastructure? There are three groups, according to Williams.

Some made their money owning dispensaries, and are eager to invest it in companies with slightly less risk on the ancillary side. Others are serial entrepreneurs; people who started their own businesses in the traditional market and either cashed out or have taken a backseat.

Most interesting, though, is the last of the three: investment vehicles. Already, representatives of large investment funds and venture capital groups are sitting at the table, getting ready to dip their toes into the water while there’s money to be made in the infant stage.

If there’s a resounding legacy from the industry’s survival of the marijuana price crash, it’s that the model has been so successful that any other state seriously considering marijuana is essentially copying Colorado’s work.

It’s also been quite good to the people who took the chance on marijuana as a legitimate business, and then remained levelheaded during the rough price fluctuations. The businesses that gave in and sold as low as they could are by and large gone. The firms that maintained their composure are thriving.

COLORADO'S MODEL IS SPREADING

The businesses that got in early already have an outstanding advantage moving forward in the legalized marijuana economy. As part of the legislation following Amendment 64, which legalized marijuana in Colorado effective Jan. 1, 2014, Colorado won’t be issuing any new licenses until eight months later, giving the existing market an immense head start.


In Denver, local ordinances extend the hold on new licenses all the way to 2016.

This means that for marijuana businesses, it's a seller's market.

Kayvan Khalatbari and Ean Seeb are two founders of Denver Relief, another successful marijuana dispensary.

In addition to building their own existing operation, Khalatbari and Seeb are becoming the go-to consultants for people who want to start their own marijuana business. With Massachusetts and Connecticut gearing up for their own rollouts of Colorado’s model, they’re very, very busy.

But besides the interstate consulting, they’ve also got their finger on the pulse of what’s going on in Colorado. Since medical marijuana licenses are tied to business entities, not people, anyone looking to cash out in Colorado is in a very good place with the forthcoming moratorium.

“If there's somebody just looking to get in here in Colorado,” said Khalatbari, “you need to buy a new system, that's just plain and simple. And, you know, those are from, let's say $50,000 for a slice, to $2 to $10 million to buy out an entire company, just because it's the company that goes along with that license.”
Since Kayvan and Ean also consult for interested parties in states just opening up their marijuana markets, they can confirm that the amount of money going into selling legal pot is simply phenomenal.

The startup costs alone are immense, as is the amount business owners need to have on-hand just to score a license. “In Massachusetts ,you need half a million in the bank and a financial letter of credit,” said Khalatbari. “In Connecticut it's $2 million. But even aside from that, if you're serious about Massachusetts, yet again there's only 20 to 35 licenses in the entire state for potentially 200,000 patients. We're dealing with 3,000 to 10,000 patients per center, so it’s going to be massive.”

What do you need in order to start a marijuana business in one of those states? The guys at Denver Relief field dozens of cold calls a day from people asking their advice on what it takes to start up a new business. The short answer? Lots of money.

“If people are honestly serious about getting in, you're going to spend probably $2 to $5 million on construction,” said Kayvan. “You're going to probably have $50,000 to $100,000 in non-refundable fees, whether that be to the state, to your local municipality, to consultants, to lawyers. $100,000 just to go into that process to apply when you might not even get a license. That's what it is right now. And then those huge, huge financial burdens on the back end to construct these massive facilities.”
This means that Massachusetts finds itself where Colorado was three years ago: Getting ready for a bunch of shotgun weddings between the money and the local growers.

IT'S ABOUT TO GET EVEN MORE INTERESTING IN COLORADO

Moving forward, things are about to get very interesting for marijuana in America.

Colorado is about to fully legalize cannabis.

What happens next — how the industry handles uncertainty when it comes to demand — could be even more interesting, from an economic perspective, than how it handled uncertainty when it came to supply.
The people in the business I spoke to didn’t think that their core market would change drastically — it’s not particularly difficult to get a marijuana recommendation in Colorado, so anybody who really wants one already has one. It’s the tourism that could shake up the market.

The thing is, nobody has any clue about what that means, numerically speaking.

Will Colorado become the marijuana capital of America? The West? The world? Is this the new Amsterdam? Nobody has any clue. So the industry is bracing itself for anything.

The marijuana that goes on sale to the general population on Jan. 1, 2014 was planted about six weeks ago.

Growers and retailers have to deal with the lead-time issue. Like Ryan Cook said, you can’t just go to your warehouse and crank up the conveyor belt. And while the Colorado industry is continuing to expand, it hasn't accelerated the growth just yet. It’s wait and see, across the board.

What happens next — how the industry handles uncertainty when it comes to demand — could be even more interesting, from an economic perspective, than how it handled uncertainty when it comes to supply.

In short, anyone who's interested in economics needs to have their eyes set on the Rockies, or they might just miss the kind of economic event that comes around once in a lifetime.

 

[trillions of atoms]

Great read thank you

 

[Dr. Green Fang]

Excellent read, cheers!