What cannabis companies need to correct over the next 12 months
Is it brand Image? No. THC levels? Nope. Retail distribution? Nada. While all are important, the one thing that matters right here, right now, is resilience. If organizations do not focus on this trait, they may not be able to weather the incoming economic storms.
December 12, 2022 By Mitchell Osak
I define resilience as the ability of an organization to adapt to difficult and adverse situations. These might include deteriorating economic conditions (e.g., inflation or a recession), or rare and devastating ‘Black Swan’ events such as wars, accidents, and environmental disasters. (Of note: Nassim Nicholas Taleb, the scholar who coined the term Black Swan, contends that they are increasing in their frequency and severity).
Corporate resilience consists of a number of traits including management perseverance, operational speed and flexibility, ability to change and risk pre-emption and mitigation.
Any insider let alone casual observer knows that the cannabis industry is being buffeted by a host of headwinds. These include, but are not limited to, inflation at the hands of fiscal stimulus, the Russia-Ukraine War, and Covid-triggered supply shortages that have led to the highest inflation rate in 40 years.
The overall rate increases to eight per cent annually with many major cannabis inputs rising well into the double digits. Particularly hard hit has been energy, labour and transportation costs. In turn, high inflation has led to rapid and significant increases in interest rates, which in turn has driven up borrowing and financing costs for cannabis companies and their suppliers.
Two issues are throwing gas on the inflationary fire. First is the rapidity at which these costs have risen over the past quarter, making forecasting, procurement and budgeting very challenging. Secondly, an industry in the throes of hyper competition and overall retail price declines do not have the luxury of easily raising its prices. Even without the recent spike in costs and rates, many companies won’t have enough of a cash flow runway to weather the storm.
Unfriendly capital markets
Cannabis firms rely on external capital to fund cash flow and expansion. During the salad days, there was a lot of money flowing into this sexy industry. Now, much of that capital is no longer available.
Three developments have led to a virtual turn-off of the capital spigots for cannabis companies:
1) Falling cannabis valuations has made it difficult to attract risk capital and execute transactions (where shares are used as currency).
2) After an unprecedented 14-year bull run, overall equity markets have substantially pulled back, resetting to more realistic levels and investment return expectations. Many investors are now seeking safe asset harbours, leading to a pullback in available risk capital. Markets are also no longer burnished by the ongoing uncertainties associated with the Russia-Ukraine War and Covid.
3) Despite hopes of liberalization, the chance for U.S. federal cannabis legalization, or even banking reform, is slight in the short term. This reality has doused the expectations of many investors who anticipated the Biden Administration to move quickly and comprehensively towards legalization. In Germany, touted to be the largest legal adult use market when it opens, most boosters have now put aside the hype and accept that legalization won’t happen until 2024 at the earliest.
Unhappy workers across every industry have been resigning in droves (the Great Resignation), spurred by Covid-induced social changes and government wage stimulus. Like other industries, the cannabis sector is challenged to attract and keep all types of labour. But unlike most other industries, cannabis must also overcome the unfair stigma of the unprofitable or dysfunctional industry to attract staff, including senior leaders.
At the same time, working in cannabis is not for the faint of heart. The industry suffers from chronically low employee engagement and corporate instability.
Cannabis is regarded as a recession-proof industry; sales did increase during the pandemic. However, this assumption has never been tested during an actual recession. We really don’t know what will happen if our economy slides into a deep recession. For many recreational consumers, cannabis is a discretionary purchase. They may cut back their purchases or shift their consumption to lower cost brands. These potential shifts create a degree of revenue uncertainty and the possibility of big inventory fluctuations and product-market misalignments.
At the risk of stating the obvious, we are living in difficult, unique, and uncertain times. Things could get even worse if possible Black Swan events like wars in the Middle East or South China Sea break out.
The way forward is by building organizational resilience and there are many ways to do this:
- Become more situationally aware: You can’t adapt if you don’t see threats coming. Create early warning mechanisms and practices that include having real time financial transparency while regularly speaking with key outsiders like suppliers and customers.
- Maximize human capital potential: Only motivated and well-trained staff can get you through difficult times. Remove pain points that limit employee engagement. Foster a culture of continuous learning to improve your key capabilities. Cross train your staff to enhance flexibility and reduce turnover risk.
- Reduce complexity: Organizational inertia is a barrier to adaptability and speed. Simplifying your product portfolios, your operational processes and practices, and organizational structure makes it easier to address problems and respond faster to threats.
- Better manage your costs: Every penny counts, especially in difficult and unpredictable economic conditions. Improve your cash management by converting fixed costs into variable costs through outsourcing, negotiation with vendors, as well as getting a better handle on discretionary spending.
- Implement revenue management: Difficult to raise prices does not mean throwing away achievable revenue. Companies can maximize revenues by closing revenue leakages (e.g., unapproved discounts, free but chargeable services) and take selected product/service price increases where your competitive position and value proposition are superior.
- Pre-empt threats: Prudent companies anticipate business interruption and unforeseen problems. They will proactively diversify their supplier base, build up financial reserves and create business continuity plans for key operational and IT systems.
Mitchell Osak is the CEO of Quanta Consulting Inc. He has supported more than 210 cannabis clients around the world with their strategy, operations and capital market needs.
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