One of the big promises of marijuana legalization was that it would end the black market. The premise was that consumers would prefer to make their purchases in a nice clean dispensary where a bud tender could wax eloquently about the terpenes and heritage of the flower. Colorful packages of tested edibles and newly created beverages would be so enticing that shoppers would have no desire to stick with "their guy."
Now it seems the opposite has happened. The black market, which the industry prefers to call the illicit market due to the negative connotations of describing the illegal market as black, is strong and fighting hard to stay in business. The recent NCIA (National Cannabis Industry Association) Northeast Cannabis Business conference in Boston made the topic the subject of a no press allowed meeting, followed by a public discussion. The trade group will publish a paper on the subject as well.
While it was admirable that the organization recognized the problem and made it the keynote subject, the takeaway was mixed. In other words, lots of talk but very little with regards to action steps to combat the problem.
Vivien Azer, senior analyst at Cowen & Co. said, "We now assume that 80% of the market will remain in the illicit trade in 2020, as it seems less clear to us that heightened enforcement will materialize this year to facilitate purchase migration to the legal trade." That means millions of dollars in sales will not be counted by legal companies.
One of the biggest problems for the nascent legal landscape is that the cannabis community itself can't decide where it stands on the subject. Activists in the industry have started referring to illegal operators as legacy businesses. A nice sweet term that doesn't seem to fit with the counterfeit operators who sold Vitamin E laced vape pens that resulted in the deaths of 68 people and caused over 2800 reported cases of e-cigarette, or vaping, product use-associated lung injury (EVALI). Or the farmers who commit ecological crimes while their tax paying, rules following competitors struggle to pay bills.
The illicit market is really split into two categories. The first are the unlicensed operators including farms and dispensaries that don't want to give up profits to taxes or pay for the high price of regulation. This also includes consumers who prefer to stick with "their guy" they've known for possibly years and whose product is considered better and cheaper. The other category are the counterfeiters who knock off the legal operators with popular brands.
TILT Holdings (TLLTF) derives a large portion of its revenue from its vape company Jupiter. While imitation is supposed to be flattery, Jupiter said that the illegal profiteers are definitely impacting the company. "Our large supply and brand reputation puts us as targets," said Jordan Walker, Director of Engineering at Jupiter Research. "With the scale and wide footprint that our organization has, it's a clear indicator of our success and makes us a target."
He said that unsuspecting brands may purchase from counterfeit technologies, and overtime will find that they do not perform to its standards. The vape crisis helped to educate the consumer that brands can be easily knocked off, but it's very difficult for the unsuspecting consumer to know what is fake and what isn't. Walker said, "Several overseas online distributors who sold counterfeit technology have been sued and stopped, they claimed they did not know what they sold was counterfeit and they have promised to cease selling those items." If the distributors can't recognize a fake, then how will a consumer be able to discern what is real and what isn't.
As Azer noted, the market isn't providing definitive guidance on the subject. Walker said, "The cannabis industry is in its infancy, and as such we aren't provided with as many legal channels to go after counterfeits as other more regulated and widely accepted industries." Some tech companies are creating QR codes as a way for brands to show customers that what they are buying is real, but that requires the brands to pay additional money to counteract the illegal traders and consumers are then required to download apps to scan these codes, creating a cumbersome effort to buy original.
Jupiter says it works with its factory partners to expose illegal operators and also keeps its ear to the ground through social media. One website called The Blacklist features anonymous posts of fake products in an effort to combat the problem and protect consumers. Yet, it seems the cannabis trade organizations and activists have to decide at some point that the grey and illegal markets will need to cease to exist.
Of course, this is a multi-faceted problem. States and municipalities could help by reducing the multiple layers of taxes and fees driving up the costs of the end products. Azer noted in a recent report that illicit products are priced 80% lower than legal products. Federal legalization would also allow the government to crack down on illegal operators. Ultimately it seems the first step is for the cannabis industry itself to decide where it stands. There has to be a point at which the industry decides it can no longer accept a grey market and insist that all operators get on board the legal train in order for the industry to truly mature.
However, Walker did note that since the industry has operated illegally for years, it's hard to push for people to suddenly begin following the rules. "It will take time to transition this attitude," he said. The question is whether the industry can afford to lose 80% of its market and still make a profit.