Why Would You Want to Break Up Vertical Integration?
Vertical integration is risky business.
A vertically integrated company owns every step of a product’s value chain. The assumption is that quality and consistency can be better controlled when every step of the process occurs in-house. In some cannabis markets, it’s required by law, but vertical integration not always in the best interest of the consumer or the business.
First, it forces cannabis startups to become an experts in all aspects of the industry — from cultivation and extraction to marketing and sales. Second, vertically integrated companies need to raise massive amounts of capital to build out infrastructures like greenhouses, extraction labs and retail stores. And third, in markets that mandate vertical integration, a crop failure can halt sales entirely, since purchasing from third-party suppliers is prohibited.
As the industry evolves, we will likely see cannabis companies resemble other consumer packaged goods companies, in which leading businesses specialize in only one component of the value chain and focus on doing it well. Growers, extractors and retail operators will likely be separate companies that concentrate on dominating the market in their areas of expertise.
From a commercial cultivation standpoint, it makes sense. Heinz doesn’t grow tomatoes, Budweiser doesn’t grow hops and Philip Morris doesn’t grow tobacco. These companies buy raw ingredients from farmers, and the cannabis industry should be no different. By eliminating the requirement for vertical integration, cultivation businesses can concentrate on what they do best: cultivation.
But I suggest taking this segmentation one step further. To decrease the risk of vertical integration and remain competitive in the future, cultivation businesses should consider specializing in only one stage of the cannabis cultivation process.
This is not a revolutionary concept. Elsewhere in commercial horticulture, specialization is the norm. It is unlikely that the flowers you buy at your local garden shop spent their entire life inside that greenhouse. More likely, the plant spent time hopping between specialists in the production chain before landing on the retail shelf. One grower typically handles stock plant production and serves as a rooting station for vegetative cuttings. From there, rooted cuttings are shipped to a grower that cares for the plants during the vegetative stage. Once they’ve reached an appropriate height for flowering, they’re shipped to the last grower to flower out and sell to retailers.
Cannabis businesses should consider imitating this model as a way to stay competitive in the future. In the United States, federal law does not yet allow for the interstate transport of plants containing THC, but the process can be segmented within states where vertical integration is not a requirement. As we look ahead to full federal legalization in the U.S., we should anticipate companies abandoning the vertical integration model in favor of specialization. In countries where cannabis cultivation is federally legal, entrepreneurs should consider specialization from the moment they begin planning their business.
What would this model look like? Cultivators that specialize in breeding and genetics could sell seeds, rooted cuttings and tissue culture services to commercial growers. Royalties could provide a recurring source of income after the initial sale of seeds or young plants. Contracting propagation activities to a specialist can result in consistently clean rooted cuttings that arrive certified disease-free for less than it costs to produce them in-house using traditional cloning methods. This not only frees up space at the recipient’s grow facility and saves them money, but it eliminates the risks inherent in conventional mother plant and cloning processes. If a mother plant becomes infected, all future generations will exhibit that disease, and the time, money, energy, labor and space required to maintain healthy stock plants are substantial. Growers that focus on large-scale cultivation would do well to outsource this critical step.
Intermediary growers could specialize in growing out seeds and rooted cuttings into mature plants that are ready to flower. These growers would develop this starter material into healthy plants with a robust, vigorous root system. They would also treat the plants with beneficial insects and inoculate the crop with various biological agents to decrease the plant’s susceptibility to pest and disease infestations. Plants would stay with this grower until they are the appropriate size to initiate flowering.
The final stage in the process would be the flower grower. Monetarily, this is the most valuable stage in the cultivation process, but it’s also the most expensive. This facility would have the proper lighting, plant support infrastructure, and environmental controls to ensure that critical grow parameters can be tightly maintained throughout the flowering cycle. The grower would be an expert in managing late-stage insect and disease outbreaks, and they would be cautious not to apply anything to the flower that would later show up on a certificate of analysis, rendering the crop unsaleable. This last stage would also handle all harvest and post-harvest activities — because shipping a finished crop to another location is inefficient and could potentially damage the plants.
Competition and price compression are sure to put a squeeze on commercial cannabis growers to remain profitable in the coming years. Cultivation businesses that want to position themselves for future success should identify their strengths in the crop-production process and consider specializing in just one part of it. It’s a business model that has proven successful over the last few decades for commercial ornamental and vegetable growers, and it’s the sign of a dynamic and mature horticultural industry.
Commercial growers that are keen on carving out a future in the cannabis industry should focus on just one stage of the cultivation process and excel at it.