Cracking Down on the Cannabis Illicit Market to Save Legal Sales

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

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

While the illegal market problem is prevalent across the U.S., the problem is significantly larger in some states than others. California is a perfect example, and it’s a problem that has been going on for many years.

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 illicit market to dominate “as much as 80% of the cannabis market in California.”

Since that time, there has been greater focus on enforcing laws to stop and prevent illicit cannabis operations in the state. In March of this year, California’s Department of Cannabis Control (DCC) released its 2021 and 2022 enforcement statistics that shed light on what has been done to combat the illicit market in the past two years:

“DCC-led search warrant operations increased from 62 in 2021 to 155 in 2022, a 150 percent increase. DCC also seized over 41,726 pounds of illegal cannabis in 2021 and more than 144,254 pounds in 2022, a 246 percent increase. Arrests more than tripled, with 17 in 2021 and 56 in 2022. And DCC led operations that seized $243,017,836 worth of cannabis last year, a 212 percent increase from the $77,772,936 seized in 2021.”

California isn’t the only state with an illicit market problem. Illegal sales in Massachusetts accounted for 75% of the market in 2019 as did more than 50% of cannabis sales in Washington and Oregon. While the problem continues in these states, there has been some progress. At the end of 2021, Oregon lawmakers assigned $25 million to combat illicit growers and began implementing initiatives to crack down on illegal growers in 2022 with some success.

States with newer cannabis programs are learning from more mature markets, but not quickly enough. For example, New York’s legal adult-use market has been significantly harmed by illegal growing and sales. This month, the Office of Cannabis Management (OCM) enacted new regulations in the state budget to address the illicit market, but the fines, penalties, and other measures are being referred to by people outside the OCM and Governor’s offices as too little too late.

5 Factors Causing the U.S. Illicit 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 illicit market.

2. Local Regulations

When local municipalities ban cannabis businesses or delivery, 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 illegal 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 illicit 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 the thriving illegal cannabis sales throughout the country that are happening in unlicensed storefronts as well as unlicensed grow operations.

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 illicit market using the legal market as a shield.

How Canadian Cannabis Companies Fight the Illicit 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 was up from 10% in September 2019. The new lower-priced cannabis products positioned as the “value” segment were targeted to people who were buying from the illicit market in an effort to lure them to the legal adult-use market.

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

Efforts in Canada to shift sales to the legal market started to work in the second quarter of 2020, when legal cannabis sales in Canada outpaced illegal sales for the first time. The Cannabis Council of Canada believed the shift away from the illegal market was largely due to the fact that legal cannabis was being sold at more competitive prices. Data shows they could be correct in that belief.

A 2022 Health Canada report, Canadian Cannabis Survey 2022, found that the shift from illegal to legal sources continues. In 2020, the annual report found that 37% of Canadian cannabis consumers “always” purchased cannabis from legal providers. The percentage rose to 43% in 2021 and 48% in 2022. In contrast, the number of people who “always” obtain cannabis from illegal sources has declined from 9% in 2020 to 7% in 2021 and 5% in 2022.

Key Takeaways about the Cannabis Illicit Market Hurting Legal Sales

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

Originally published 1/21/20. Updated 5/29/23.

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