Cracking Down on the Cannabis Black Market to Save Legal Sales

Today, the illegal cannabis market continues to thrive – even in states that have legalized adult-use cannabis. As more states work to roll out new recreational cannabis programs this year and others are expected to approve adult-use cannabis through legislation, it’s essential to consider what’s happening in the illegal markets within states that have operational adult-use cannabis programs.

While there are several reasons the black market is still doing so well, some cannabis companies are starting to fight back with more effective product positioning in Canadian markets, and U.S. brands should pay attention.

The lesson to learn is branding and product positioning will become essential to succeeding in the U.S. cannabis market in the near future – just as it is in other industries.

How Canadian Cannabis Companies Fight the Black Market with Product Positioning

According to a study by Headset, the value-priced segment of the cannabis market in Canada (i.e., products with a retail price of $6 or less per brand) accounted for 40% of all dried flower sales in July 2020, which is up from 10% in September 2019. ‘

New lower-priced cannabis products in the “value” segment are targeted to people who currently buy on the black market in an effort to lure them to the legal adult-use market. Once customers transition to the legal recreational market, the goal is to upsell them to higher-priced products.

Aurora Cannabis Inc. and Canopy Growth Corp. both released value-priced products in Canada in recent months to capture some of the black market and help their revenues. In fact, Canopy Growth plans to be the value product market share leader in the recreational market, which CEO David Klein expects will grow to about 50% of the overall adult-use market.

It appears efforts in Canada to shift sales to the legal market are starting to work. During the second quarter of 2020, legal cannabis sales in Canada outpaced illegal sales for the first time.

Specifically, Statistics Canada reported that spending on recreational cannabis during that time reached $648 million (a 74% increase from the same period in 2019), and spending on medical cannabis was $155 million (flat with the same period in 2019). When compared to illegal sales during the second quarter of 2020, which hit a new low of $784 million, sales of legal medical and adult-use cannabis accounted for 50.5% of the market.

Fast-forward to June 2020, and Statistics Canada reported that the legal cannabis industry was responsible for a $5.44 billion contribution to Canada’s gross domestic product (GDP) compared to $3.89 billion for the black market.

According to BNN Bloomberg, the Cannabis Council of Canada believes the shift away from the black market is largely due to the fact that legal cannabis is being sold at more competitive prices.

What’s Happening in the U.S. Cannabis Black Market?

While the black market problem is prevalent across the U.S., in some states the problem is significantly larger than others. California is a perfect example.

In its 2019 draft annual report, the Cannabis Advisory Committee warned California legislators and Governor Gavin Newsom that a combination of high taxes, onerous regulations, and local bans allow the cannabis black market to dominate “as much as 80% of the cannabis market in California.”

What does 80% of California’s cannabis market mean? Here is some data from the Cannabis Advisory Committee’s report to provide perspective:

  • Illegal sales are three times higher than legal sales: In 2019, legal cannabis sales in California were expected to reach $3.1 billion compared to $8.7 billion in illegal sales.
  • Tax revenue is about one-third of what the state expected: $1 billion in annual tax revenue from cannabis was projected with the passing of Proposition 64 that legalized adult-use cannabis, but the fiscal year ended June 2019 recorded just $288 million in taxes collected. The estimated tax collection for the coming fiscal year is just $359 million.

California isn’t the only state with a black market problem. Illegal sales in Massachusetts account for 70% of the market as do more than 50% of cannabis sales in Washington and Oregon.

In other words, despite the fact that legal cannabis products should be safer and higher quality than illegal products, a large number of consumers across the United States still choose to buy from the black market than through licensed businesses.

5 Factors Causing the U.S. Black Market to Thrive

Many cannabis industry advocates cite taxes, local regulations, licensing delays (and caps), a lack of law enforcement, and strict state regulations as some of the primary reasons that illegal cannabis sales continue to thrive. Let’s take a closer look at each.

1. Taxes

When states and local municipalities add burdensome taxes to businesses across the supply chain and to consumers, the result is a trickle-down effect that ends with higher prices for consumers. For many consumers, particularly those who have prior experience buying cannabis from illegal sellers, the price difference is too big to ignore. Rather than paying excessively more to shop at legal dispensaries and retailers, consumers choose to buy from the black market.

This is a problem the National Cannabis Industry Association (NCIA) is watching closely as New York moves closer to legalization of recreational cannabis through legislation. Governor Andrew Cuomo is pushing a legalization plan for adult-use in 2021 with the hope to use tax revenue to offset the state’s $4 billion budget deficit. However, the NCIA has been working with the state to ensure taxes aren’t so prohibitive that they’ll push more people to buy from the black market.

2. Local Regulations

When local municipalities ban cannabis businesses, it’s more difficult for consumers to purchase cannabis products. As a result, it’s easier for consumers to buy from illegal sellers. Why travel to buy when a consumer can buy more conveniently and spend less money through the black market?

3. Licensing Delays and Caps

Many states’ cannabis laws limit the number of business licenses that can be issued. If there aren’t enough licenses to service customers conveniently, many will turn to the black market. In addition, many states haven’t issued licenses in a timely manner. Therefore, consumer demand isn’t met and illegal sales continue to thrive.

4. Lack of Law Enforcement

Many industry professionals argue that a lack of law enforcement is at least partially to blame for thriving illegal cannabis sales throughout the country that are happening in unlicensed storefronts as well as unlicensed grow operations.

Other types of illegal cannabis activities that need to be addressed fully are counterfeit products and advertising scams. For example, counterfeiters actively sell fake cannabis products at illegal shops and online, and black market sellers know how to get around advertising laws to show their ads across the web.

5. State Regulations

State regulations can make it extremely difficult for businesses to operate in the legal cannabis industry. From high application and licensing fees and exorbitant taxes to massive capital outlays and overly-burdensome compliance requirements (including testing, tracking, and more), being part of the legal cannabis industry can be excessively expensive and challenging. As a result, many people choose to continue operating in the black market using the legal market as a shield.

Key Takeaways about the Cannabis Black Market Hurting Legal Sales

Until taxes (and prices) are lowered, regulations are eased, and accessibility improves for consumers, the black market for cannabis in the United States will continue to thrive.

However, legal cannabis businesses can make their products more competitive with the illicit market by carving out their own niches through effective branding. Product positioning is already showing some success in the Canadian cannabis market in terms of luring sales from the black market.

Originally published 1/21/20. Updated 2/12/21.

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