Ontario Cannabis Store: Bringing Competition to Cannabis
By: Christina Nemez
The Ivey Business Review is a student publication conceived, designed and managed by Honors Business Administration students at the Ivey Business School.
Stirring the Pot
When the cultivation, distribution, and sale of cannabis was legalized across the country in 2018, Ontarians aged 19 and over found themselves able to purchase cannabis online for the first time through the Ontario Cannabis Store (OCS). The OCS was the consumer’s only access point before the first brick-and-mortar dispensaries opened in April 2019.
Federally, Health Canada regulates the cultivation of cannabis and leaves the responsibility of selling and distribution to the provincial level. In Ontario, the Alcohol and Gaming Commission of Ontario oversees retail operations, and the sale and distribution is regulated by the Ontario Cannabis Retail Corporation (OCRC) under the Ministry of Finance. Initially, the OCRC stated the OCS’s online retail option would be temporary. However, with nearly 1,400 dispensaries currently operating in Ontario, the OCS remains the sole wholesaler and only online retailer of recreational cannabis in Ontario. As such, all brick-and-mortar retail stores are required to purchase their cannabis inventory from the OCS.
The Budding Value Proposition
When legalizing cannabis, Health Canada and the Government of Ontario considered three main goals: keep cannabis away from youth, eliminate the unregulated cannabis market, and protect public health. These reasons were the impetus for the creation of the OCS and its current model, with the OCS also providing extensive monetary benefits for the government. The Government of Ontario profits off of cannabis in three ways: excise tax, sales tax, and OCS earnings. These revenue-collection avenues, especially the OCS, have resulted in massive additional economic activity for the Canadian government and public; cannabis has added around $44 billion to Canada’s economy since legalization.
The OCS provides a substantial benefit for recreational and medicinal consumers with third-party laboratory tests that ensure THC and CBD concentration is accurately advertised. In addition, legal cannabis is tested for unapproved pesticides, deleterious metals, foreign substances, and bacteria; laboratories also ensure cannabis products meet potency specifications for cannabinoids like THC and CBD. Unregulated marijuana has been shown to be contaminated with microbes and pesticides that were otherwise negligible or not present in regulated products. A concerning study conducted in the U.S. showed that of 300 online merchants, 98 percent were found to be non-compliant with at least one product. One product tested was even found to contain 18.5 times the amount of allowable lead, illustrating that the prevalence of the gray market must be reduced in consideration of public health.
Trimming Competition
The presence of the OCS eliminates competition from retailers and wholesalers due to its legislated ability to act as a price-setter. The OCS maintains control over the cannabis market by sourcing from licensed cannabis producers (LPs), marking up prices by over 70 percent, and then selling these products to consumers through its website and retailers. OCS is also the only source of legal cannabis products to other retailers, meaning all retailers have access to the same products at the same cost. Through this tactic, OCS controls the margin between the price it charges retailers and the price retailers are able to charge their own customers. Subsequently, dispensaries are unable to operate in a truly competitive market as the system establishes a margin floor and ceiling for retailers created by OCS’s markups.
For consumers, the noncompetitive OCS procurement system results in higher retail prices. According to the Globe and Mail, pricing is one of the top three considerations for consumers when making a purchase decision for cannabis consumption. Thus, if the OCS is structured as the sole price-setter in Ontario’s cannabis market, inflated prices might deter consumers away from legal channels and into the gray market.
Weeding Supply Chain Issues
Licensed producers can only sell their cannabis to the OCS during one of their four product calls per year. This inventory is then sold and distributed to retailers and consumers, creating a regulatory framework that bars any vertical integration in the industry. Aggressive centralization can make it difficult for small-scale growers to meet product call deadlines; many farmers finish their harvest in mid-late October and November, which may prevent them from meeting October product call deadlines.
The high degree of centralization also creates logistics challenges with inventory. In early 2021, OCS’s Vice President of Merchandising, Marketing, and Ecommerce sent out an email to stakeholders stating that the OCS is attempting to better refine the product call system to allow flexibility for producers getting products into the market. However, with problems persisting, Ontario’s Auditor General Bonnie Lysyk expressed concern in December 2021 over the OCS’ demand forecasting capabilities and stated that “product availability has been a common complaint from retail stores.” When comparing actual against forecasted demand, some cases showed that there were 145 percent more orders than available products. The inaccurate forecasts made by the OCS mean that there is a discrepancy between what products are for sale and customer demands. Without reasonable incentives for OCS to improve their supply chain, the company has still yet to complete a formal analysis to quantify the gap between orders and forecasts.
In addition to high prices, product availability can be easily affected by the centralized nature of OCS’s operations. If customers cannot rely on their local dispensary to meet their product preferences and pricing needs, they are more likely to seek gray market products. In 2021, the OCS reported that at least 45.8 percent of Ontario’s cannabis sales were unregulated. As a consequence, the uneven playing field paved by the OCS contradicts the initial reason for their existence, which was to protect public health.
Leaf-ing Centralized Wholesale
As of March 2021, Ontario legal cannabis was priced at approximately C$9 per gram, compared to gray market cannabis which sold for as little as C$7.76 per gram. In contrast, research suggests that legal product prices have reached parity with gray market cannabis in Saskatchewan. Thanks to a structure that allows dispensaries to become vertically integrated through partnering with local LPs, Saskatchewan retailers can now buy in bulk and package cannabis products themselves. Additionally, giving dispensaries the ability to select their own licensed suppliers allows them to differentiate on more than price and location: exclusive flowers and strains create opportunities for distinction and subsequently customer attraction.
Taking lessons from Saskatchewan’s precedent, the OCRC should discontinue its iron grip on cannabis distribution by allowing suppliers to seek their own wholesalers. Private contracts between LPs and retailers could be executed where prices are negotiated and terms of agreements can be disclosed to regulatory authorities. The OCS could continue selling products via its website to establish a benchmark for customers looking to compare prices.
Additionally, decentralization of cannabis procurement and distribution would create more resilient supply chains that can remedy inventory shortages within the OCS. Forward-looking cannabis retailers are already expanding logistics; earlier this year, Fire and Flower Corporation acquired Pineapple Express, a controlled substance logistics company specializing in the delivery of cannabis products. Vertically integrated supply chains will also improve demand and supply forecasting abilities, allowing these companies to respond promptly to fluctuations in market demand. This, along with the fact that certain LPs also own retail locations, indicates that the industry is primed for such efficiencies. This strategy may also create more room for product innovation, as retailers and LPs can communicate directly about consumer demand.
While increased competition in the Ontario cannabis industry should lower the price of products in general, tax revenue from cannabis sales will not necessarily decrease. Should the price of legal products reach parity with the equivalent unregulated products, consumers will be more incentivized to purchase legal cannabis. In addition, a higher variety of products would allow the market to cater to a broader range of preferences — ones that might currently be served only by the gray market. This allows the legal market to further grow market share. Even with a stable market size, the government will be able to tax a larger portion of the market, which will offset lower selling prices due to competition.
Stubbing Out the Grey Market
In order for the legal market to outcompete an unwanted gray market, Ontario must change its regulatory structure surrounding cannabis. As a crown corporation, the primary mandate of the OCS is to support the responsible consumption of cannabis, while protecting the youth and vulnerable populations. By transitioning to an oversight role, the Ontario government has an opportunity to maintain control over the safe and legal consumption of cannabis, while allowing retailers and producers to thrive and become more competitive in a budding market.