As provincial governments put in place regulatory frameworks in time for the legalization of recreational cannabis, they’ve been faced with a major public policy challenge. They have to navigate questions such as price, quality, availability, and public safety, while evaluating whether decisions will inadvertently support the illicit market. To complicate matters, some of the aspects of the legal market are beyond the control of the provinces – Health Canada controls licensing of the producers, with a lengthy application process and high barriers to entry.
Saskatchewan announced its regulatory framework in early 2018. The government revealed it would rely on the private sector for distribution and retail sales. While the private sector model carries many benefits that could undermine illicit sales, vertical integration or concentration in the retail segment of the market may allow dominant firms to charge inflated prices and reduce the competitiveness of the legal market.
Saskatchewan’s retail licenses
The provincial government has awarded 51 retail licenses in 32 locations. The process was open to all, including firms based outside the province and federally licensed producers. Applicants were assessed only on the basis of good moral character and adequate financial resources. Once all the applicants were screened, a lottery was held to award permits. No applicant could be awarded multiple licenses in the same location, which effectively caps the total number of licenses awarded to a single firm at 32.
Ultimately, one-third of the retail licenses (17) were awarded to just five companies, with Tweed Grasslands (Canopy), a federally licensed producer, winning 5 of the licenses, more than any other applicant. In total, 14 licenses were granted to firms listed as or known to be federally licensed producers. Four of the licenses were granted to organizations with explicit links to First Nations. The licenses will be fully transferable once operations begin. Distribution licenses will be awarded in a more direct process, as there is currently no limit on the number of distributors in the province.
There are several advantages to Saskatchewan’s retail and distribution systems. First, by engaging the private sector, Saskatchewan’s legal market will be more responsive and better able to compete with the illicit market than a public system. Concentration and transferability of retail licenses will also make enforcement easier as there will fewer firms to oversee in the industry, which was the impetus for Colorado’s requirement that retailers also be producers. In addition, the financial threat of having a transferable license withdrawn will be a major inducement for compliance.
Although only 27.5 percent of retail licenses were initially awarded to licensed producers, transferability means large producers with cost advantages, substantial financial backing or both will be able to purchase retail licenses from other applicants. Given the recent acquisitions among producers (sometimes at many times the market value of a particular company), it is likely that large producers will establish a significant presence in all the most profitable locations.
The risk of concentration in the retail market
There is a benefit to a concentrated, vertically integrated industry. The greater financial resources of larger firms will help them withstand competition from the illicit market while consumers make the transition to the legal market.
But market concentration has long been acknowledged to reduce competition among firms. Dominant producers ensure their product is featured most prominently across retail outlets, engage in pricing and other strategies to designed undercut retail competitors and prevent new producers from accessing retail markets, resulting in lower variety and/or lower quality. This could keep consumers buying in the illicit market.
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Concentration ratios already feature prominently in the Competition Bureau’s guidelines on mergers and acquisitions – no single firm should control 35 percent or more of a market, nor should the largest four firms control 65 percent or more of the market. These ratios seek to prevent situations where concentration negatively impacts consumers because of higher prices, lower quality or less variety. The initial allocation of retail licenses in Saskatchewan fell within the guidelines, but if firms merge and expand this could change. If four large firms have eight retail outlets each the bar will be surpassed.
Meanwhile, issues of product testing, quality control and matching consumer preferences mean there is no guarantee that legal products will be seen as a suitable alternative for the illicit cannabis that is currently available, particularly if consumers hold strong anti-corporate attitudes. Seven of the initial retail licenses were awarded to large corporations, which anti-corporate consumers may avoid on principle. If they do, a retail market dominated by these and/or similar firms will have more difficulty competing with the illicit market than with a legal market composed of smaller independent firms.
The high degree of private sector involvement in Saskatchewan’s nascent legal recreational cannabis industry bodes well for its ability to compete effectively with the illicit market compared with other jurisdictions whose retail is government-run. But this success will likely come at the expense of less competition in the legal market, higher consumer prices and the diversion of benefits away from the people of Saskatchewan. In addition, the lack of regulation to prevent vertical integration or level the playing field for retailers is likely to lead to higher prices and less variety than would exist in a more competitive market of smaller independent firms. These higher prices in the legal market will allow for a larger illicit market in the medium to long run.
The Government of Saskatchewan could have mandated a single government-run or overseen distributor in the province to eliminate the potential of vertical integration (as most other provinces have done). Another alternative would have been to preclude licensed producers from owning and operating retail outlets, as BC did.
The lesson of Saskatchewan’s cannabis market is that governments looking to attain the benefits of private retail markets need to establish a counter-balance to market power when there is a likelihood of concentration or vertical integration.
This article is part of The Economics of Canadian Cannabis special feature.
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