The concept of loss leadership, a pricing strategy where a product is sold below market cost to stimulate the sale of more profitable goods and services, is receiving considerable attention in the cannabis space currently.

Here in California, amid aggressively falling cannabis prices at the wholesale level, smaller farms are cursing corporate operators for intentionally dropping prices to force them out of business.

Is there a widely adopted, sinister corporate play to snuff out family farms in the Golden State, or is a highly competitive market in a capitalistic nation simply playing out as one could expect?

Terminology Matters

To begin with, it seems that labeling the current state of affairs as “loss leadership” is misguided. While it’s been documented that retail cannabis establishments use loss leadership as a pricing strategy, i.e. selling a line of pre-rolls on the cheap to attract buyers and steer them into products with higher margins like cartridges, packaged flower, or dabs, I haven’t found literature supporting this at the wholesale level.

More correctly, I’d argue that larger corporations have more efficiencies of scale, and can “afford” to move products cheaper than others. In this context, I’d argue that they are deploying market penetration pricing, whereby they accept smaller short-term margins on sales, in exchange for greater market share, and ultimately higher profits once they have won over a larger customer base.

Capitalism, Costs, and Price Pressure

What seems to be the case in California cannabis, specifically, is that price compression is more of a structural reality versus a more devious outcome of a corporate design.

Firstly, California produces a lot of weed – more all the time, in fact. As I’ve written about in the past, with vast amounts of production and relatively few retail outlets, supply far outpaces demand and prices fall. This happens with all commodities and agricultural products and cannabis is no different.

Additionally, cannabis is a discretionary purchase for most consumers. While some segment of the population uses based on medicinal need, most consumers, especially with respect to adult-use markets, use casually. Given that inflation is rampant right now – people are spending far more on everything else. Gas, food, clothing, pet supplies, home care products, durable goods, and many services are rapidly increasing in price.

With more money going to living expenses, most average consumers simply have less to spend on weed. Government stimulus has slowed and retail cannabis companies are noting how much average purchases have fallen. One dispensary owner I spoke to recently said people used to spend a couple of hundred dollars in the shop, now they spend $40.

As demand slacks off, prices fall – it’s basic economics.

Up and down the supply chain businesses, like consumers, are facing rising input prices. Packaging materials and other supplies used in value-added segments like manufacturing are up considerably and hurting profits. With this in mind, companies need to control costs in other areas, like what they pay for cannabis flower, biomass, or bulk extracts.

So while it is easy (and popular) to curse loss leadership for California’s cannabis woes, like many things in life, the truth seems more complicated.

Forced Loss Leadership

More than anything, it seems that cannabis operators have been forced into a downward pricing strategy, not so much by design, but by circumstance. Ever-increasing competition, growing supply, softening demand, and the need for lower input prices has shredded the price for pounds and more is likely to come.

Desperation

Aside from the market forces discussed above, desperation, not ill intent forces some producers further into a downward pricing spiral. Low-quality product, the need to fund operating expenses, or service debt can create a real need for cash in the cannabis space – especially given that lending and access to the banking system are still limited in the sector.

As capital needs mount, desperation ensues and operators of all sizes can be forced to move product quickly. Buyers, happy to capitalize on cheaper stuff, will gobble it up and convert distressed pricing into the new normal. Just as black-market buyers in Nor Cal cite The Pines as a source on the cheap, legal distributors cite Salinas, Santa Barbara, and desert grows in an effort to grind down sellers a few bucks a unit.

As long as there are ample numbers of growers in the game, someone is always forced and willing to sell at a lower number. Pricing contagion is real and a downward cascade ensues.

In my view, California has reached a point where the market no longer clears. Weed used to get harder to find in early spring and summer and prices would melt-up, padding the pockets of those who held over flower or had early deps. That is not really happening anymore.

Year-round production is now significant in Cali, and more is coming on line all the time. This fact only exacerbates desperation and forces cash-strapped farmers to sell on the cheap.

After a very brief window in which prices firmed, things seem to be dropping off precipitously again. We are hearing $600-800 for bulk deps, pre-packaged pounds a bit better. Last year, which ended very poorly for prices, pounds were much higher at this time.

As the season matures and supply burgeons further against the backdrop of inflation and looming recession, I anticipate many producers experiencing a cash crunch. With looming financial obligations, folks will be forced to sell – cheaper and cheaper I would assume.

The legal cannabis industry has proven to be a real challenge. Some of the largest multi-state operators and global giants like Aurora are posting huge losses – hundreds of millions to billions a year. Investment flooded the industry but inflow is slowing, or at least becoming more scrupulous.

Interest rates and the cost of capital are rising and investors are getting grumpy, demanding a return on capital. I anticipate failures, takeovers, and forced liquidations over the coming months. Caught in the middle of this all will be millions of pounds searching for a home. My guess is that prices will continue to grind downward – not based on a corporate loss leadership strategy, but because of industry and economic dynamics.

Things can change, but for the moment, it seems like challenging times are brewing. I received two calls this week that troubled me further and illustrated the case I’m making here, ample product with limited distribution equals falling prices.

The first was from an acquaintance who had “tons of deps and ins” at $400 to $800 a unit. The second was from someone looking to move many, many pounds of pre-packaged one-gram jars of sauce. Both were in relation to the traditional market.

If the illicit market, which accounts for an estimated 75-80 percent of the total cannabis market, is similarly struggling to move product and is slashing prices in May, how might we expect this year to play out on the West Coast?

Perhaps eliminating the cultivation tax, as proposed for July 1, will shake things loose a bit and get a bit more capital moving around, but barring that, I expect prices to far surpass last year’s lows, until the point when so many operators fail that the supply/demand balance comes back to a closer equilibrium point.

Like in every recession or challenging period within an industry, opportunity still exists. Several well-established brands look to source truly exceptional flower and the full terpene extract market continues to garner attention. It’s time to saddle up, control costs, boost yields, perform at your very best, and brace for what looks to be a wild ride.

All my best to Humboldt and beyond,

Jesse