Why marijuana supply chain is key to NY legalization

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An icy breeze blows off the shores of Seneca Lake, rattling the glass panes of the Cornell University greenhouse in Geneva, a small city in the northern Finger Lakes about an hour east of Rochester.

Inside the greenhouse — part of Cornell’s AgriTech satellite campus — it is warm and humid.

Graduate student Jacob Toth walks down the center aisle of the greenhouse until he reaches a locked door, a “No Trespassing” sign posted beside it. He takes out his keys, unlocks the door and steps into a scene unimaginable in New York just a few years ago.

”This one we got from Oregon,” Toth says, approaching the first row of plants. He pinched an instantly recognizable five-pronged leaf between his fingers. “They said it was a good grain fiber variety.”

Inside this subsection of the greenhouse, Toth is growing hemp plants. Lots of hemp plants –– several rooms’ worth, in fact.

At Cornell, Toth is part of a state-approved research project breeding hemp plants specialized to different products, from fiber to CBD oil to, perhaps one day, recreational marijuana.

Toth’s research encompasses another aspect of the budding hemp industry in New York: the marijuana supply chain.

HOW NY SUPPLY CHAIN MIGHT WORK

For years in New York, the supply chain for pot has existed outside the legal realm, conducted through underground market distribution channels hidden from government regulators.

Now, the decisions that state lawmakers make as New York works toward legalization will help shape a new supply chain, dictating the price, quality and variety of marijuana sold in the state.

Experts, for instance, say California’s regulations have created a chaotic supply chain and a free-for-all on the ground, with illicit suppliers and counterfeit products that have harmed consumers.

Meanwhile, states like Nevada and Massachusetts may have over-regulated, which can force out small businesses and farms while increasing prices and limiting choice for consumers.

At its simplest, a supply chain is the process through which a product passes from producers to consumers. The chain determines, among other things, how long it takes for products to move from a farm or factory to store shelves and what prices consumers ultimately pay.

”A supply chain is how information and material flow from the initial source of supply to the end consumer,” said Gary La Point, professor of supply chain practice at Syracuse University’s Whitman School of Management. “Then information goes all the way back upstream again. So it’s like a continuous loop.”

Supply chains are so essential to modern economics — controlling the price and production of every good we use — that consumers often don’t realize they exist at all.

In the case of marijuana, the supply chain dictates how a hemp seed in a farmer’s field reaches dispensary shelves as a product packed for sale.

”This process has been underground for so long,” Toth said. “There’s no precedent for it.”

WHAT TO KNOW ABOUT SUPPLY

Existing legal marijuana supply chains are largely similar to that of any other agricultural commodity.

The plant is grown by farmers and cultivators, processed by manufacturers, sold by retailers and used by consumers. Since each step of the supply chain costs money to carry out, the price of marijuana — or any product — will increase as it moves further along the supply chain.

”There’s the manufacturer, there are distributors, there’s the transportation,” La Point said. “All those things go into the ultimate price. Everyone’s got to get paid for doing something.”

In weed-legal states, mandated third-party testing, which ensures that the product is free of contaminants and within approved THC levels, adds an extra step to the supply chain, albeit an important one for consumer safety.

”We need product testing. We need consumer protection,” said Tim Fair, a lawyer specializing in marijuana and cannabis laws.

Fair’s legal service, Vermont Cannabis Solutions, advises entrepreneurs looking to enter the legal marijuana market.

”What we don’t need is overregulation,” he said.

The type of over-regulation Fair warns against can come in many forms, including licensing.

In states that have already legalized recreational marijuana, such as California and Massachusetts, the legislature determines how many companies can operate at each level of the supply chain by issuing licenses.

These licenses allow a company to execute a certain function along the supply chain — growing the crop, processing it into various products or selling it.

Together, testing and licensing allow the government to track the product as it moves up the supply chain, ensuring safety standards for consumers. But these measures can also limit competition in the marijuana market, Fair said.

”There really needs to be a tightrope walk on this matter,” Fair said. “Too little regulation doesn’t work, and too much regulation doesn’t work. It needs to be just the right amount.”

How New York state legalizes recreational marijuana — what testing standards it puts in place, what licenses it issues — will determine whether the marijuana supply chain will succeed in New York, Fair said.

Too much regulation, he warns, would stifle competition and give leverage to large companies, shutting out small businesses and farmers. Too little, on the other hand, would put consumers at risk.WHY MARIJUANA TESTING IS KEY

States that have legalized recreational marijuana have instituted third-party testing requirements to protect consumer safety.

But the scope and nature of testing laws vary widely from state to state. The differences can have major implications for who can enter and succeed in the recreational marijuana supply chain, Cornell’s Toth said.

Reasonable third-party testing requirements are necessary to protect consumers, Fair said. But testing, like any step along the supply chain, costs money. And if those costs are too high, third-party testing requirements can be prohibitive to smaller operations looking to break into the marijuana industry, he said.

”If it becomes this ridiculous overregulation, the only people who can conform to that are those who have lots of money to do so,” Fair said. “It just ends up pushing out the small guy.”

As testing requirements have increased and more states move towards legalization, testing itself has become a lucrative business. In the cannabis market, for example, a market research firm projected the third-party testing industry would reach $1.4 billion in value by 2021.

In states like California, Florida and Massachusetts, where recreational marijuana supply chains already exist, the state requires growers to submit representative samples from each batch of harvested marijuana for testing. If the sample fails to meet state standards, the entire batch is prohibited from sale.

But what amount of product constitutes a “batch” can have a substantial impact on the cost incurred by marijuana processors, Toth noted. This problem has already arisen in the CBD industry, he said.

”Testing is a big problem for the CBD market right now. Depending on how you interpret [the regulations], it might require testing a plant per acre,” Toth said. “If you’re testing so many acres, it can get expensive.”

But by raising the cost of production, testing has had an unfortunate side effect, the experts said.

One of the hoped-for benefits of legalization is the end of the underground market for marijuana, which isn’t subject to safety testing or taxes. But too much regulation means the underground market may continue to flourish, even in the presence of a legal market.

Even in states where recreational marijuana is legal, underground supply chains persist as cultivators and consumers try to avoid the higher prices associated with taxes, testing and regulation.

”The standards of production are really high and the taxes are really high,” Toth said. “So the producers will produce, the good quality stuff will end up on the legal market, and their bad quality stuff might end up on the black market.”

Even if New York institutes a legal marijuana supply chain, it will face competition from existing illegal supply chains, Toth said.

HOW INTEGRATED SUPPLY CHAINS WORK

Similar to testing, licensing also allows state governments to exercise a degree of control over the marijuana supply chain.

But licensing rules, like testing requirements, vary widely from state to state. Each state’s legislature can determine how many types of licenses it will issue, and how many of each license to distribute.

Licenses give state legislatures the power to limit the number of businesses that operate at each level of the supply chain. This can either limit efficiency and harm consumers or create a market that is too chaotic to effectively regulate, Fair said.

”You can see what happens in California when you give a license to anybody. It’s chaos,” Fair said. He also noted the New York medical marijuana market — in which 10 dispensary licenses were initially issued for the entire state — as an example of licensing that was too restrictive.

Typically, states grant licenses to the highest bidder, or to companies that can pay licensing fees. The fees generate revenue for states and can ensure that companies have the capital necessary to comply with state regulations.

But they may also pose a barrier to entry for smaller operations looking to break into the recreational marijuana industry. Instead, less established cultivators, processors, and retailers may have to turn to other hemp products to make a profit.

The cost of entry into the market is a critical piece in New York, where lawmakers want to ensure communities of color have opportunities to open marijuana businesses.

”For legal marijuana, the cost of the licenses will affect who can get into the industry and benefit from it,” Toth said.

Licensing could pose another challenge to the marijuana supply chain in New York: integration. Depending on how many of each license a company may own, the state legislature may help create a supply chain that is horizontally or vertically integrated, Fair said.

In some cases, this could allow the state to more effectively regulate the industry. If mismanaged, it could stifle competition and create a monopolistic environment resulting in higher prices and fewer options for consumers.

By allowing companies to purchase one of each available license — for example, selling a growing, processing, and distributing license to the same business — New York may create a marijuana supply chain that is vertically integrated.

Some states encourage or mandate vertically integrated marijuana companies, as they allow the state to more efficiently regulate and track the product to ensure consumer safety.

”If you can grow your own, produce your own, and sell your own, that’s going to make you the most money,” Fair said. “As long as you’re getting a third-party test to make sure those products are safe, that’s not a bad thing.”

The greater threat to competition in the marijuana market is horizontal integration, Fair said.

In a system with complete horizontal integration, a single company controls an entire step of the supply chain without any competition, allowing them to set prices as high as they would like, to the detriment of consumers and other businesses in the supply chain.

”If there’s no competition, you’re in a monopolistic environment,” La Point said.

”Then you can set your prices, but you have the risk of having the government step in if your prices are too high.”

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