In October, Quebec-based pot producer Hexo Corp. announced the unveiling of a new cannabis line comprising a hybrid blend of sativa called “Original Stash.”
Most newsworthy about the new line of pot: it marked a significant price reduction for the cannabis seller, with 28-gram packages priced at just $4.49 a gram — less than half the average retail price, and lower even than the average cost of cannabis on the black market.
“Our aim with Original Stash is to disrupt the illicit market, educate consumers about the value of a regulated and tested product, and drive them to purchase their cannabis legally,” said Sebastien St-Louis, Hexo’s CEO and co-founder, in a press release. “We’re now competing directly with the illicit market and providing consumers with an affordable, controlled, quality product.”
The company’s decision to lower prices shines a spotlight on a growing problem for Canada’s licensed cannabis producers. Since the drug was legalized in 2018, legal companies have had difficulty drawing in users who rely on the illicit market, largely due to how expensive legal prices are and how difficult it is to obtain.
In fact, according to Statistics Canada, a full 40 per cent of users still purchase from illegal dealers.
“Cannabis users have a source of supply that they’re comfortable with and that they like, and they need to be given a reason to change,” said David Soberman, a professor of marketing at the University of Toronto. “To get them to switch you need to make the product available and it needs to be a price that’s comparable to the black market.”
To compete with the black market, sellers like Hexo have dropped their prices. In July, the government of Nunavut reduced its markup on dried cannabis flower from $4 per gram to a mere $1 per gram. Some retailers, like the Ontario Cannabis Store (OCS), offer a small selection of products matching the prices of the black market, though additional tax and shipping costs often hike those prices substantially.
As of September, the average retail price of legal cannabis per gram was $10.23, while the average price of illegal cannabis was $5.59, according to crowd-sourced numbers from Statistics Canada.
At a shop like Hunny Pot in Toronto, for example, the cheapest pre-rolled joint starts at $6.49, before tax.
But price lowering tactics come with risk. Shortly after unveiling Original Stash, Hexo’s shares plunged as much as 11 per cent, to the lowest level since 2017, as the company reported a fourth-quarter loss three times greater than analysts’ expectations. Though the company’s trouble began before they lowered prices, the decline in projected revenue as a result of the lower prices was enough to spook shareholders, Soberman said.
“When you lower your prices, your margins will also be lower. So, if the production cost of a cannabis leaf is somewhere under $5 and you’ve started selling grams for $5 instead of $10, people are going to worry about the margin you’re going to generate,” Soberman said.
“Cannabis companies need to determine a balance that offers cannabis for a lower price to be competitive, but not so low that investors will doubt the company’s future.”
To add to the complications, producers in Ontario selling to government retailers negotiate their prices with the government beforehand. These prices will be determined based on quantity, quality and the cost of production. Growing indoors using artificial lighting, for instance, can be double the cost of growing in a greenhouse, excluding the additional costs of packaging and delivery fees.
Authorized retailers in Ontario adhere to a wholesale pricing structure determined by third-party retail experts, though critics like Michael Armstrong, a professor at Brock University, say the success of the illicit black market proves the structure is inadequate.
“The illicit market isn’t going out without a fight, and the (Ontario) government and cannabis companies will have to work together to make sure they can actually compete,” Armstrong said.
According to Soberman, the benefits of lowering prices outweigh the benefits of keeping prices high. “Sure, you have to be pretty efficient to make money at lower prices, but while it might hurt on a per-unit basis, if at a $10 price-point you sell nothing, but at $4.50 you sell a ton, then it’s clearly much better to do the latter,” he said.
In the last three months, the OCS has implemented price reductions on 50 different products and has increased its availability of dried flower products priced at under $10 per gram (HST included).
Alanna Sokic, a consultant with Global Public Affairs, says a lower cost for cannabis must be accompanied by a significant increase in retailers in order to undercut the black market while keeping legal companies profitable.
“Until we make strides on access to legal cannabis, lower prices might not matter much,” she said. “There needs to be a reason for the consumer to find it more convenient to access a legal store than a nearby dealer.”
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Currently, there are 24 licensed cannabis stores open in Ontario, with the government in the process of licensing 50 more. In September, the Ontario Cannabis Retail Corp. reported a $42-million revenue shortfall in the last fiscal year, leading the province to order the OCS to re-evaluate its business model.
Though Hexo’s Original Stash is well below the average retail price, some analysts have cast doubt on the product’s viability in attracting illicit pot users.
In a report that was published shortly following Hexo’s Original Stash unveiling, Jefferies Equity Research questioned how successful the new brand will be “given current legal demand is for higher quality.” Referencing the one-ounce minimum quantity, the report also noted that “the $125 price is not consistent with illicit purchasing habits.”
Soberman said companies will need to be strategic about marketing at lower price points to properly attract new users.
“As a producer, at some point you have to decide: are you going to participate in this business or not? Because if the market exists at a lower price point, but you’re asking yourself if you should set a higher price, then you should really be asking if you should be in the market at all.”
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