Abstract
The state-legalized marijuana industries in the United States, both medical and recreational, are providing entrepreneurs and investors with remarkable growth opportunities, albeit with some serious business risks and challenges. This case study provides an overview of the developing industry based on the third state to approve the sale and use of recreational marijuana and a couple of young entrepreneurs’ new retail venture. Consideration of a substantial offer to buy their business forces the valuation of their largely effectual results, and consideration of alternatives .
The Offer
Cristy and Tate stared at each other for a moment then both stared again at the letter on the desk in their narrow office in back of their store. Just a couple of years out of college, and barely 2 months after opening Cannabis & Glass (C&G ), a retail recreational marijuana store in Spokane, Washington, they had a cash offer of US $750,000 for the recreational marijuana retail licence and their fledgling store business. They had paid US $250 to apply for the licence, another US$500 to incorporate the limited liability corporation (LLC) and had about US$1,000 inventory on hand. Every time he plugged the numbers into a return on invested capital (ROIC) formula, Tate chuckled and said out loud, ‘You gotta love it when a good plan comes together.’
Industry History
Originating in Asia, various subspecies of cannabis have been harvested for as long as 12,000 years, making it one of humankind’s oldest harvested crops. The first documented reference to medicinal uses of the plant is from China circa 4000 BC. The subspecies with psychoactive qualities that produce intoxication are collectively referred to as ‘marijuana’ and include Cannabis sativa, Cannabis indica and Cannabis ruderalis. The non-intoxicating subspecies Cannabis sativa L., commonly known as ‘hemp’, produces tough fibres used for cordage and fabric and seeds for high-quality oil.
Cannabis has a long history of industrial, medicinal, recreational and even spiritual uses and is cultivated worldwide. Between 2.7 per cent and 4.9 per cent of the global population has consumed cannabis at least once, with higher consumption rates in North America, Europe, West and Central Africa and Australia (Exhibit 1). In North America, the annual prevalence of cannabis consumption usage for 15 and 64 years’ olds was estimated at 11.6 per cent in 2013. 1
For the last century or so cannabis cultivation and consumption has been criminalised in most countries. Cannabis was effectively outlawed in the USA through the Marijuana Tax Act in 1937. In the early 1970s, the Controlled Substances Act classified cannabis in any form as Schedule 1, referring to the very worst illegal drug substances, with high potential for abuse, no known medical applications and no established ‘safe’ level of usage.
A Changing Industry Environment
Despite nearly 80 years of US federal and state controls, with harsh punishment for convicted criminals, marijuana flourished illegally. Throughout this period, the plant was widely grown, processed, distributed and consumed, sustaining a huge criminal industry both in the USA and outside its borders. A White House report estimated 2010 US consumption expenditures for marijuana of US$41 billion for approximately 5,700 metric tonnes of product (White House, 2014).
The trend towards more social acceptance of marijuana usage was underway since the late 1960s. In 1978, the New Mexico legislature passed the Controlled Substances Therapeutic Research Act establishing the Lynn Pierson Therapeutic Research Program to consider the potential benefits of medical marijuana. In 1996, California became the first state to legalise marijuana for medical usage with a board-certified doctor’s prescription. By late 2014, some surveys showed a majority of Americans favoured legalising marijuana and 23 US states had already legalised medical marijuana usage in some form (Exhibit 2).
Grassroots political efforts to decriminalise marijuana were aided and organised by advocacy groups like the National Organization for the Reform of Marijuana Laws (NORML). Even opponents of decriminalisation began to favour marijuana legalisation over the negligible results of nearly 80 years of prohibition. In effect, both sides were agreeing that the most effective way to eliminate the illegal industry and control the substance was to legalise it, control it and tax it, much like alcohol.
With very little criminal problems associated with legalised medical marijuana, ballot initiatives to legalise recreational usage gained momentum. In 2012, Colorado and Washington passed legislation to legitimise recreational marijuana. Alaska and Oregon followed 2 years later (Exhibit 3).
State Legalisation of Recreational Marijuana, December 2014
The ‘Legalized’ Cannabis Industry
According to a report by The ArcView Group cited by
Colorado and Washington state regulations differed in a number of ways. Colorado implemented a unified system to regulate both medical and recreational marijuana, and permitted a single business entity to produce, process and sell marijuana products, albeit with limitations. In the first 9 months of 2014, Colorado’s unified marijuana industry tax collections grew from 113 per cent in September to US$62 million, up from US$46 million in January, based on a 2.9 per cent sales tax, a special recreational tax of 10 per cent and a 15 per cent excise tax, plus business licence fees (Colorado Department of Revenue, 2014).
Washington did not implement a unified medical and recreational system like Colorado. Medical marijuana in Washington had relatively few regulations compared to recreational marijuana. Limited personal cultivation was allowed for medical but not recreational, and medical had no robust tracking requirements nor packaging requirements nor guidance on transportation and distribution included in the provisions. In addition, the entire state of Washington was not open to the new recreational industry. Of the 75 most populous cities, 37 per cent enacted moratoriums on licenced marijuana businesses and 7 per cent enacted outright bans. Some were clearly waiting to see how things unfolded before considering what to do, but others seemed intent on banning the industry outright.
Both states were legitimising a range of activities that remained felony criminal offences at the federal level. All assets and profits associated with the marijuana industry were legally subject to seizure by the Feds, like any other Schedule 1 criminal drug activity. Even with a documented understanding with the US Attorney General that the federal government would not prevent the implementation of the states’ marijuana industry initiatives, the Feds still had every right to take legal action, including prosecution and imprisonment of participants.
The State of Washington Industry
For recreational marijuana, the implementation of Initiative 502 that legalised the state industry designated the Washington State Liquor Control Board (LCB) as the administrative agency. The LCB, in turn, issued nearly 50 pages of additional rules and regulations, including a ‘seed-to-sale’ tracking and monitoring system covering three types of commercial licences: producers (growers), processors and retailers. Unlike Colorado, in Washington, a single business entity could not hold all three licences but could hold a producer and processor licence. In other words, retailers were separated in the supply chain and could hold neither a producer nor a processor licence.
Washington imposed a 25 per cent recreational marijuana excise tax on the value added by each link in the supply chain: producer to processor wholesaling, processor to retailer wholesaling and retail to consumer sales. Another 6.5 per cent state sales tax was applied to all retail sales, that is, on retailers only. Cities were allowed to charge an additional 1 per cent sales tax to create revenue to support operations associated with accommodating and enforcing the new industry. Business and occupation taxes and business licencing fees were applied to all three types of licensees as well. State taxes collected in the first 5 months of the legal recreational marijuana industry totalled US$14.2 million based on total sales of US$48.5 million.
Producer licences permitted both indoor and outdoor growing and harvesting, trimming and curing marijuana plants. Three tiers of licences distinguished the size of the grow operation, designated ‘Plant Canopy Limits’, applied to both indoor and outdoor growing. Two things became apparent based on the regulations. First, the plant canopy limits would produce just a fractional of the state’s demand estimates. Second, the ‘seed-to-sale’ control system was technically robust in ensuring that all legally grown usable marijuana made it to a legitimate market, and all the legally grown marijuana by-product was destroyed.
Licenced processors transformed usable marijuana into shelf-ready retail products and distributed products to retailers. The seed-to-sale system provided that all products sold by processors were sealed and ready for sale by the retailer. Retailers were not permitted to open or re-package the processor’s products. Processors could make other consumable products for retailing, including concentrates and edibles. Processors had the responsibility for packaging and labelling, including branding product names and logos, but also in compliance with the rigorous state mandates for labelling of content, harvest date, tracking numbers, potency, purity and health and legal warnings. Purity and potency had to be provided by third-party laboratories.
One of the biggest business challenges for licence applicants was finding a location to accommodate operations. State and local governments imposed zoning regulations that included at least a 1,000-foot buffer from schools, playgrounds and public park/recreational facilities, among other specific public and private establishments frequented by minors. It created a commercial real estate boom around the limited available locations that met regulations. Though retailers were less constrained by square footage requirements of producers, they had much more consideration of the marketing implications of storefront location including traffic volume and pattern, parking accommodation and signage/advertising potential.
A RAND study commissioned by the Washington LCB estimated marijuana usage in 2013 for the state of Washington at 175 metric tonnes, about 385,875 pounds. Just three counties in the Seattle area accounted for about one-half of that estimate: 30 per cent King County that includes Seattle, Washington’s biggest urban area; 11 per cent Snohomish County just to the north of King County; and 11 per cent Pierce County just to the south of King County.
The study classified consumption as usage in the past year, past month or near daily. According to the RAND study in 2013:
‘Near-daily’ consumers accounted for about 80 per cent of all usage and consumed an average of 1.5 grams per day. ‘Near-daily’ consumers’ average annual incomes were below US$20,000. ‘Past-year’ consumers tended towards higher-than-average incomes. Male/female ratio increased with increasing usage. Compared to national averages, both Washington and neighbouring Oregon have more marijuana users reporting ‘some college’ education.
Most consumers reported using conventional bud (flower) forms of marijuana. Half of all consumers reported having edible marijuana products occasionally, but few reported having them often. Other processed products, such as ‘kief’ (marijuana flower crystals), ‘hash’ oil extract and resin and infused beverages, were more commonly reported by near-daily users and rarely used by less frequent users.
The Spokane Market
The Spokane River valley runs through the northeast corner of Washington State, a good 4-hour drive east of Seattle on Interstate 90. Though it is a bit remote, the city of Spokane is the second largest in Washington State with a population just over 200,000, with an additional 300,000 residents in surrounding Spokane County. It is situated about 100 miles south of the Canadian border and just 20 miles west of the bordering panhandle of Idaho, where marijuana remained illegal, with Montana another 75 miles east of there.
Home to Gonzaga University, Whitworth University and Eastern Washington University, the Spokane valley’s economy has its roots in mining and timber, and some transitional twentieth-century manufacturing base. The city itself struggled economically from time to time, despite some success in diversifying its economy towards more service-based businesses. The 2014 per capita income for the city was US$25,642, about US$5,000 below the state-wide level, and median household income was US$49,233, about US$6,200 below the state-wide level (Census, 2015).
There was little resistance to the implementation of Washington’s recreational marijuana industry in the Spokane region. It appeared to provide a boost to the agricultural economy, to real estate values and to local employment. The state limited licencing to just 18 retail recreational marijuana shops across the county, including 8 within the city of Spokane and 3 in neighbouring Spokane Valley, of the state-wide 334 retail shops (Note 2).
Spokane Green Leaf opened in July, one of the state’s first. Its early opening received lots of free press coverage, which supported a first-mover advantage. That quickly eroded as other stores opened. Recreational marijuana sales topped US$1 million by November and were up by another 22 per cent in December. By that time, all eight licenced retail shops were opened, with the top three, including Spokane Green Leaf, commanding about 60 per cent of the sales. All three stores had excellent retail locations, a wide variety of product offerings and substantial inventory (Exhibit 4).
While retail recreational sales grew substantially, totals were nowhere near the demand. The medical marijuana supply and demand seemed unaffected so far. Illegal marijuana sales and distribution continued, though likely diminished by the legitimised industry. Average street prices for illegal marijuana dropped from US$15/gram in July to about US$7/gram by the end of the year.
Cannabis & Glass
Cannabis & Glass opened in November 2014, the eighth and last retail store to open in Spokane. Compared to its competition, C&G was distinctly low profile. Cristy and Tate, C&G ’s owners, opted for the lowest rent location they could find, with limited floor space and off of the main traffic routes. It was in a mostly residential neighbourhood, easy to find but certainly not a high traffic area of Spokane. The building had a dirt parking lot behind a high barbed-wire fence and no signage at all. Unless you knew what you were looking for, there was no way to tell that it was a retail recreational marijuana store.
With limited floor space, the store was designed for efficiency. They allocated only 200 square feet to the customer area and kept the remaining 600 square feet for an office and a secure safe room. Unlike any of the other local stores, they created a fast counter-service experience where customers enter the store, wait in a queue dictated by stanchions, step up to a counter to speak with a ‘bud tender’, order off a limited chalkboard menu and then exit the store directly. Tate reasoned that a more traditional retail layout with displays and more counter-space would require employees and more fixed overhead.
2014 Spokane Retail Marijuana Sales
With C&G ’s low-cost location and the other stores fighting over the high end of the recreational cannabis market, Cristy and Tate targeted the lower end of the market with a tagline of ‘affordable recreational cannabis for everyone’. For advertising, they were counting on Cristy’s media capabilities. By using Facebook, Twitter and other social media platforms, they reached out to their target market without incurring the high costs associated with traditional marketing channels. This would build a large, positive and digitally vocal customer base.
The location and marketing decisions were consistent with all the decisions they made in launching C&G . They were both just a couple of years out of college and had been supporting themselves. Cristy left George Washington University in her third year of study in political communications to take a dream job as a reporter in Missoula, Montana. She met Tate as he was graduating from Montana Western University with an entrepreneurship degree. They had similar values and attitudes—a little adventurous, a little conservative and very careful with their money. After a brief courtship, they started saving for a ring.
In November 2013, Tate asked Cristy to consider quitting her job to move and establish residency in Washington for the chance at one of the first legal marijuana licences. It seemed like a once-in-a-lifetime opportunity. In Montana, Tate knew of a local restaurant that changed hands recently, and the liquor licence sold for US$600,000. He wondered if that might be done with a legal cannabis licence.
So they pulled out maps and first considered the Seattle area, but were put off by the high cost of living. Moving without jobs and not much savings would make it hard enough to launch a business, if they were lucky enough to get a licence, so they settled on Spokane. While they were establishing residency, they both became licenced real estate agents and started building a ‘digital agent’ business model. Cristy was very adept at leveraging social media and digital advertising and was intent on turning that capability into some deals and commissions.
Neither Tate nor Cristy let their families know what they were considering. The plan was to make a windfall profit by simply arbitraging a retailer licence—selling it without ever opening or operating the business itself. They spent US$500 to form an LLC, used their real estate savvy to secure letters of intent on a few potential retail locations and paid the US$250 application fee.
When C&G won the retail licence for Spokane in the April 2014 lottery, the offers to buy the licence started coming in even before they were officially issued by the state. Some of the offers were weird and some seemed legitimate, but all were for several thousand more than they had invested. They continued selling real estate and watched the other stores open first. They had very little money to open a store themselves. As they considered what to do with the offers, the LCB threatened to revoke the licence if they did not open a store within 60 days, apparently in reaction to other ‘arbitrage’ deals in the state.
Then some unexpected capital showed up. Cristy closed a sight-unseen real estate deal with an online client from China and collected a US$15,000 commission. Tate received an unsolicited US$10,000 business line of credit from a local bank based on his real estate business endeavours and his excellent credit rating. Suddenly they had plenty of working capital. With very little downside risk based on the offers for the licence, it seemed that opening a business could only increase the value of the licence. They really had nothing more promising anyway, considering the real estate business drops off in the winter months in Spokane.
Fearful of losing the licence they had risked so much to get, Tate and Cristy secured the lowest rent location they could find to launch C&G . They knew that all the opened stores competed for the ‘high end’ of the market with wide product selection, inventory to support the selection and high prices. The store prices were roughly twice the illegal street price, allowing the black market to thrive despite legal recreational access points that could serve anyone over 21.
Part of the elevated legal price supported the 25 per cent state excise tax levied on producers, processors and retailers. Those taxes were not deductible on federal income tax returns, as the industry was still completely federally illegal, so all state-legal cannabis businesses were substantially double-taxed. New stores were also motivated to recoup their business investments as quickly as possible and knew that initially some people would buy legal cannabis for the novelty factor regardless of price.
Tate also looked at processor sources and production. There was a widely reported initial shortage of product from the producers and processors, as growers ramped up volume and strains (brands) and figured out how to comply with all the controls in the state’s ‘seed-to-sale’ inventory tracking rules. This upstream learning curve in the supply chain increased cost pressure downstream on processors and retailers. But Tate easily established relationships with the processors and identified plenty of lower-cost potential inventory that was less-than-perfect for the high end of the market. Product that did not package quite as nicely or had been on the shelf for more than a month and even packaged ‘trimmings’ from the processors could be profitably sold at near-illegal street prices of US$7/gram.
Cannabis & Glass opened in November 2014 with US$500 of inventory, which initially supported 2–3 days’ sales. This required an accelerated inventory turn that had Tate constantly in buying mode with various processors, and he quickly learned the system. He was able to leverage publicly available data on production, retail volumes and prices in his negotiations. All these data were a matter of public record, though it seemed relatively few of the other retailers were using the information.
Tate had just 3 months of retail experience selling athletic shoes, and Cristy had virtually no retail experience, with a business background limited to her recent real estate agency. In their new store, she was the ‘bud tender’ behind the counter with the inventory and cash register. They held off on hiring employees partly because of their bootstrapping approach to the new venture and partly because they planned on selling the business and licence pretty quickly. With a new industry and such limited retail experience, mostly they were effectuating—making things up as they went along and adjusting as they learned. That meant working 80–90 hours a week every week, not getting out much, and in these first few months, not telling family what they were doing. It was exciting, a bit scary, but left almost no time for family, friends and fun. The 7 weeks since opening seemed so much longer in so many ways.
The business was immediately both cash flow-positive and profitable (Exhibit 5 & 6). This created an immediate banking problem. Because the entire industry was still federally illegal, banks were not willing to jeopardise their charters by taking in ‘drug money’. Therefore, in addition to carrying inventory that invited potential criminal interest, they were also literally carrying around large amounts of cash.
Just before Christmas, and just after debating what to do about seeing family over the holidays and explaining what they had been up to, a substantial offer to buy the business and licence showed up in the mail. It was a certified letter, very professional with all the earmarks of a lawyer’s touch, and it was from a Spokane-based LLC. Tate knew he had a substantial financial backing. The offer seemed legitimate and amounted to a cash offer of US$750,000 for the licence and business, including the lease obligation.
So now Tate stared at Cristy with a sly grin. This is exactly what he had hoped for when he asked Cristy to quit her job and move to Spokane. They had achieved their aspiration following the principles of effectuation and affordable loss that Tate had learned in his degree program. On the other hand, they had launched an interesting little business in a new industry, and what they learned gave them some pause. If the licence was worth US$750,000 to these buyers, what might it be worth to others? And if it was worth US$750,000 with the business now, what might it be worth in a year if the business was successful? What would that amount of cash be worth after taxes, and what would they do next if they sold out? Effectuation had brought them this far, but it seemed an inadequate approach to valuing the offer and informing this big decision. And no matter what they decided, what were they going to tell their parents over Christmas, just a few days away?
C & G Income Statement 2014
C&G YE 2014 Balance Sheet
Case Study Discussion Questions
‘Trace the successful launch of C&G to the principles of effectuation. Describe Cristy’s and Tate’s actions in terms of who they were, what they knew at the time, who they knew, what they had and what they were willing to lose.
‘Of the US$750,000 offer, how much value would you attribute to the C&G business model, and how much would you attribute to the business licence from the state of Washington LCB? If the business is sold, do you think the new buyers would continue the business model and strategy?
‘What core competencies are required to succeed in the C&G low-cost strategy? If you were to forecast growth, what are their prospects for revenues, margins and returns?
‘Would you advise Cristy and Tate to accept the cash offer, to counter-offer with different pricing or terms or to reject the offer?
Teaching Notes to Accompany Effectuation and Valuation: Cannabis & Glass Case Study
Teaching Objectives
Illustrate the principles of effectuation in creating a new venture
Contrast effectual and causal problem-solving
Forecasting growth of a new business with significant uncertainty.
Case Overview for Instructors and Discussion Facilitators
Effectuation and Valuation: Cannabis & Glass provides entrepreneurship instructors and students an interesting vehicle to bridge the principles of effectual logic and causal logic in business problem-solving. With clear edges to the business, industry and market situation, it provides an approachable student platform for analysis and discussion. The case works well as the basis for classroom discussion and analysis in an open classroom, on discussion boards and within smaller student teams. Ideally, the case study is placed in coursework after the principles of effectuation have been covered. Prior coverage of the fundamentals of strengths, weaknesses, opportunities and threats (SWOT) analysis is helpful.
The case opens with a young couple, Cristy and Tate, considering an offer of US$750,000 to buy their retail recreational marijuana business and licence. Their shop, ‘Cannabis & Glass’ in Spokane, Washington, USA, has been open barely 2 months in a newly legalised state industry that is nonetheless illegal at a federal level. With about US$3,000 invested in the business, the purchase offer represents a huge windfall for them. The questions that frame the case—should they accept the offer, negotiate a better offer or grow the business themselves—depend on a valuation of the business and licence, and invites consideration of what got them this far and what they think they can do with their fledgling business strategy.
Illustrating Principles of Effectuation in Entrepreneurship
Discussion Questions: Trace the successful launch of C&G to the principles of effectuation. Describe Cristy’s and Tate’s actions in terms of who they were, what they knew at the time, whom they knew, what they had and what they were willing to lose.
The couple starts their entrepreneurial adventure with very limited means beyond their knowledge, experience and willingness to work hard. With fairly vague aspirations to start a successful venture, both Tate and Cristy imagined their prospects and risks based on what they had, who they were, what they knew and whom they knew. The marijuana licence lottery in Washington was but one of many ideas they considered.
Their shared financial conservatism supported a minimal threshold of affordable loss as they took the steps towards the lottery for the licence, in waiting to open the store and in launching C&G with a minimal investment. Students might note that even though they had access to US$15,000 plus a bank line of credit, they invested only a few thousand dollars in the business, indicating their own notion of affordable loss. The low-cost strategy of C&G was at least as much an artefact of the owners’ personalities as it was a deliberate strategy choice.
As their means grew—the combined real estate commission and business line of credit—it enabled new aspirations, altered goals and new possibilities. The actions of the young couple in every instance were based on what they had on hand. They did not wait for a perfect opportunity but used what means they could control to take their next step, demonstrating the effectual principle of ‘a bird in hand’. Their move to Spokane was calculated on what they could afford while waiting to see if they won the licence lottery. They used what little means they had to launch the real estate business and then to launch C&G . With the buyout offer in hand, they again reconsider their means and what possibilities it enables.
Cristy’s journey from journalism student to entrepreneur illuminates actions based on ‘what you know’. They leveraged her knowledge and her millennial, digital native mindset in the real estate business and in the C&G business launch. She proved the value of her social media knowledge when the sight-unseen real estate deal closed, providing all of the capital necessary to launch the venture.
Tate’s appetite for information and data helped him understand the business and market opportunity in Washington and the evolving marijuana industry value chain. There is little evidence in the case study of the ‘crazy-quilt’ principle of effectuation. The couple did not seem to seek nor form partnerships with people or organisations. There are just the two characters depicted in the case study, limiting the ‘who you know’ principle of effectuation. On the other hand, the couple knew each other, and a deep partnership is depicted in the success of their shared values and mutual respect for each other’s capabilities.
Contrast Effectual Problem-solving with Causal Resource-based Reasoning
Discussion Questions: Of the US$750,000 offer, how much value would you attribute to the C&G business model, and how much would you attribute to the business licence from the state of Washington LCB? If the business is sold, do you think the new buyers would continue the business model and strategy?
Because the business is so new and thinly capitalised, its value is minimal. The potential buyers could easily copy the low-cost/low-price strategy without buying C&G , as long as they had a state retail licence. The purchase offer is really for the licence itself, and the case discussion should consider the future possibilities enabled by the licence. The potential buyers could continue the C&G name and store model, use the licence to launch a new store or simply resell the licence.
The state-issued licence is clearly valuable, rare, inimitable and non-substitutable, serving a resource-based view (RBV) of sustainable competitive advantage. Its value is demonstrated by their initial success. It is rare, being limited by the LCB, although that could change. The licence cannot be imitated, and the next best substitute is illegal. So what is a ‘best estimate’ of what the business is capable of doing, what key capabilities they would need and how quickly they could grow C&G ?
Compared to an effectual ‘strategy’, a causal strategy demands vision and mission instead of vague aspirations, financial and strategic objectives instead of possibilities and a plan and timeline to achieve those objectives. Market demand is no problem in this case. The low-cost/ low-price market positioning of their retail business aligns to the largest segment of the market, which is converting from illegal purchases to the newly legalised channels. That provides a somewhat legally uncertain but quantifiable forecast of growth prospects for C&G .
Forecasting Growth of a New Business with Significant Uncertainty
Discussion questions: What core competencies are required to succeed in the C&G low-cost strategy? If you were to forecast growth, what are their prospects for revenues, margins and returns?
While effectual logic assumes that the future cannot be effectively predicted, causal logic demands a forecast of future business conditions and a strategy that best exploits it. Cristy and Tate, by effectuation or luck, have a low-cost/low-price strategy that seems to fit the market opportunity. Seventy five to eighty per cent of consumption by volume is attributable to a ‘lifestyle’ segment of near-daily consumers. Combined with the lower-income demographics of the segment, the majority of the market is price sensitive, with a higher propensity to substitute illegal marijuana.
Assuming students are familiar with SWOT analysis, that framework is useful in leading a discussion of external analysis of opportunities and threats, and internal analysis of strengths and weaknesses.
The future opportunities for the cannabis industry seem to outweigh the threats. Demand is already established, albeit through criminal channels. The 2014 US legal cannabis sales were US$2.7B, a fraction of the US$40B+ national industry demand estimate. Both proponents and opponents of recreational marijuana usage are enabling the legalised industry growth. Government regulation of production and consumption and the tension between state legalisation and federal regulation represent a significant threat or risk factor in the forecast. Ameliorating such risks are the social and political trends towards expanded legalisation and the prospect of interstate or national markets opportunities, and the economics of state tax revenues—for example, US$100 million in Colorado in their first year.
The industry competitive forces model (Porter’s five forces) is more useful in stable industries, based on historically verifiable industry data, but can be instructive in getting students to think through the competitive forces dimensions and how they might change over the planning horizon. To summarise the five forces in the case:
Risk of entry is low—for this industry, there is virtually no risk of entry because the limited licences issued by the state for Spokane are now active—unless the Washington LCB changes the regulations.
Intensity of rivalry is low—because demand is many times higher than supply, intensity for this industry is low at the time of the case, but the clustering of stores around approved zones will intensify localised rivalry.
Power of buyers is low—if buyers are individual customers and the sales volume per transaction is low, then the leverage of any one customer will not significantly affect sales or revenue, and therefore pricing decisions.
Power of suppliers started high because of limited inventory but appears to be moderating as the supply chain fills.
The power of substitutes is moderate, with illegal sources remaining an imperfect substitute for legal; illegal marijuana is not tested and labelled for purity, potency and harvest date, and it has to be purchased from criminals. Other substitutes may include alcohol and other drugs, but less so for the ‘lifestyle’ target market of C&G .
The industry forecast supports continued market power for the retailers, good potential for gross margins and indications of excellent growth prospects in sales and revenues. It supports the low-cost/low-price strategy of C&G , but Cristy and Tate have some weaknesses to contend with. They are inexperienced and have yet to hire an employee. They have a small shop that with real limits to sales volume. They (still) have very little financial capital. They are mutually dependent and working 80–90 hours a week with no slack resources, risking burnout or health problems that would jeopardise the operation. Their strengths include their commitment and dedication, their knowledge of the supply chain and web-based marketing capabilities and the success of their counter-sales model.
The core competencies required for a low-cost strategy are purchasing and inbound logistics to minimise costs, efficient operations to minimise expenses and effective marketing to the target segment. Cannabis & Glass have demonstrated some initial success in all three, but will have to develop purchasing expertise to secure a reliable low-cost supply to enable low prices.
Tate and Cristy reasoned that several area stores quickly grew to US$250,000 in revenues, so they used that figure as a near-term growth goal to model a forecast.
For costs and margins, the sourcing strategy was to pick off the sub-prime inventory from processors and keep it out of the supply chain to the other stores. That meant more financial and physical resources for buying and holding inventory. The benefits included greater economies of scale and negotiating power and higher gross margins.
To support the revenue forecast, the operational limits of their current store configuration became evident. They estimated the necessary inventory, the employees and the operational changes, suggesting a larger retail space and likely a new storefront. Their income statement pro forma is shown in Exhibit 1. Classroom discussion can mirror their approach to develop pro forma, or students can use the C&G pro-forma as the basis for critical discussion.
Cannabis & Glass Pro-Forma Income
Discussion Question: Would you advise Cristy and Tate to accept the cash offer, to counter-offer with different pricing or terms or reject the offer?
In preparing to discuss this case, most students discover that Tate and Cristy grew C&G into one of the largest retail stores in the region. Using the causal analysis on top of their effectual success, Cristy and Tate rejected the offer outright. They were confident that the monthly pro forma forecast could be achieved in just a few months with upside revenue potential in the first year roughly double the forecast, if they could accommodate the sales. They moved to a bigger store and leveraged their counter-sales model with motivated employees. Within 18 months of the case situation, the store was generating over US$750,000 revenue per month, they acquired a second licence and were opening a second store.