Too High to Survive

When examining the current state of cannabis, we must focus on two distinct groups: consumers and operators. They are the primary drivers of the market's existence, notwithstanding the role the government plays in designing the legalized marketplace. They also bear the brunt of taxation that can discourage or attract consumers to the market, and the highest number of licenses are distributed to this category.

Consumption and approval of cannabis have been steadily on the rise since the adult-recreational use was legalized. The chart to the right is the National Survey on Drug Use and Health (NSDUH) Prevalence of Past-Year Cannabis Consumption, Unadjusted⁵. It indicates that cannabis consumption in California, while lower than in other Pacific coast states, was roughly 11% in 2002-03, and has risen to approximately 25% as of 2021-22. This is a strong indicator that the state's legalized and regulated market is robust, with potential to grow even further, considering the untapped potential still in the unregulated market. ERA Economics, a consulting firm hired by the California Department of Cannabis Control, estimates that the “total value [unlicensed cannabis produced in state] is around $11.9 billion ($2.0 billion within the state and $9.9 billion exported)”⁶. This indicates that the licensed regulated market of $5.43B as of 2023⁷ has at least $2B in additional market capitalization, which is being untaxed and in the unregulated market because consumers have been able to find lower prices and ease of use.

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Interviews and analyses of conversations with experts indicate that California cannabis consumers have easy access to the unregulated market, which is a significant deterrent for investors and is stunting the growth of the market. A simple Google, TikTok, Instagram, or Weedmaps search highlights the locations, dates, and times of events the industry refers to as “Seshes.” These events are held in public places, some near police stations, demonstrating California law enforcement's nonchalant and hands-off approach to the issue. The Department of Cannabis Controls also mentions this as a serious concern for the industry, highlighting that “plant eradications in California are estimated to represent between 6.9 and 16.8 percent of unlicensed production that is cultivated in the state for 2011–2016, and between 7.5 and 18.3 percent for 2019–2024.”⁸ These amounts barely put a dent in the unregulated market which underscores that more law enforcement and a reignitions the “war on drugs” would not solve the provlem of a vibrant underground unregulated cannabis market in California, that is easily 

accessible to most people.

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Operators in the California cannabis industry are struggling to remain afloat, but that was not always the case. Considering that, “2016 was irresistible to cannabis entrepreneurs… capitalists wasted no time investing billions into California’s pot market.”⁹ Cultivation and retail were the early crowned jewels of the early stages of the industry, with companies like MedMen opening “Apple-like” stores with investors promising that they would “virtually print money.”¹⁰ Those days were short-lived, and now many cannabis firms/operators are either struggling to survive, are out of business, or utilizing the unregulated market to make ends meet. In an interview with an expert in the field, they noted that “95% of the income they make comes from 'direct-to-consumer wholesaling,'”¹¹ which is a euphemistic way of saying selling on the unregulated market. 

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From 2020 to 2024, there has been a steady decline in the retail price of the baseline product, dried flower, going from a high of $39 per 1/8th of an ounce to $23 per 1/8th. Typically, we would attribute declining prices to innovations in the market or health competition. These downward price pressures stem from the unregulated market, overproduction, and oversaturation. While we have already discussed the issue of increased enforcement in the unregulated market, poor business practices and rushed venture capitalist investors, mixed with a harsh and complicated regulatory system, also contributed to creating these conditions for California operators. One expert went so far as to say that a significant problem with the industry was too much capital and “not enough adults in the room making decisions,” while also highlighting the oversaturation of licenses due to unlimited access created by the DCC and local governments.¹² 

Additionally, the burden of taxes and regulations on the cannabis industry is overwhelming firms' ability to make any profit, harming the efficiency of the marketplace. A report from the DCC¹³indicates that the state currently has more cancelled or expired licenses than active ones across the supply chain. Industry experts are concerned about the industry's current pricing and taxation trends. Consumers are apprehensive about prices, and the legalized market has higher rates that push people into the unregulated market. With these conditions, the state's goal should be hyper-focused on supporting the capital financing pressures in the industry while reducing taxation and regulatory burdens to allow the industry to grow and sure up the market. 

An important subsection of California operators is social equity, which the state has designated as an area of support essential to California’s market. But what is social equity in cannabis, and how does it impact the health and viability of the cannabis market? Often, people refer to social equity as reparations for Black people or charity for individuals affected by the “war on drugs.” Social equity is a process of the government providing certain business advantages to people impacted by the “drug war” and traditionally marginalized in entrepreneurship. This differs from a rural business program for small-town economic growth or women's business programs to increase female ownership.  

The state adopted a light-touch approach in California, allowing cities and localities to determine whether and how they will implement a social equity program. The requirements generally include a residency within specific historically impacted zip codes, income limits, and/or a conviction for cannabis possession. In comparison, there may be more or fewer requirements based on local laws. However, the ultimate goal is to allow state residents to start a business in an industry where they were previously penalized. Opponents of social equity programs have argued that this is a “form of economic protectionism that limits competition and leaves small local operators vulnerable to predatory out-of-state partners and investors.”¹⁴ While I agree that some predictions of local operators being vulnerable to larger, predatory entities are valid, states often tilt the business landscape or regulatory market in a specific direction for various economic, cultural, or social reasons—for example, through the establishment of monopolies in garbage collection, subsidies on crops, or the creation of opportunity zones. California has created laws and regulations to codify social equity as a goal, alongside the health and viability of the cannabis marketplace. Therefore, as we proceed, it is essential to understand that any corrections or improvements to the industry must include the protection of the cannabis market's social equity sector. 

The core problem with regulated cannabis retail is the inability to earn a reasonable profit. For California, the most optimal outcome of creating a legalized cannabis industry would be its normalization, so that opening and financing a dispensary would be like a bar or restaurant. However, that is not the case because capital is difficult to find, and profit margins are virtually nonexistent. Utilizing the profit maximization model, I created a scenario to project the business environment for cannabis operators. My model makes some basic assumptions about the cost of starting a dispensary in San Francisco, listed below, based on interviews and conversations with over 10 experts in the field. Additional details are noted in (APPENDIX #1).

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The cost of capital is calculated¹⁶ �� × . To determine the ^��₁₂ ÷ 1 − (1 +^��₁₂)^{−(��−12)} variable cost per unit (VC) sold, I use the current wholesale price of ⅛ oz of cannabis flower ($13) and multiply it by the tax rate, utilizing this formula¹⁷ ���� = �� × (1 + ��) for a VC cost of $17.70 per unit. Total revenue was based on the assumption that this retail local would sell $1M or less of roughly 70K units of product annually at an industry-standard retail markup rate of 2.5 times the wholesale price. To determine this, I used the formula¹⁸ (���� − ����) × ���� = ����. Lastly, calculated the profits/losses by¹⁹ ���� − ���� = ������������ 

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The most important takeaway from this model is that it is an economic loser for any intelligent entrepreneur. No sane person would choose to open a business with a loss of approximately $55K, contend with high taxes, in a federally illegal industry, and have an escalating number of armed robberies and break-ins²⁰. With just one major crisis, like a robbery, debanking because of federal restrictions, unpaid supplier accounts, etc., operators are likely to enter into even more debt with very few financial options to manage it.

For example, the profit margin quickly disappears when the same model is utilized and some core variables are changed. Because it's San Francisco, and your location is in a high-crime and large unhoused community like the Tenderloin neighborhood, and you need armed security, the cost increases to $200k. Your interest rate on a financing loan from a VC firm goes to 27%, and rent goes to $25K a month. Under current market conditions, that would result in a deficit of —$300,000+.

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Some key factors to note are the higher licensing fees and application costs. State 

application costs for opening a bar that sells beer and wine in San Francisco would cost $1,500, with annual licensing fees of $1,100. Local licensing in SF is high for selling alcohol, with one-time costs between $150-300k, but this is also a conventional business with more options to finance and manage debt. Also, capital cost rates are exceptionally high in the cannabis industry, unlike the hospitality field, being between 17% and 30%, because of the risk of losing federal banking insurance (FDIC) due to its illegality. For my model, I used the lower end of that scale. Finally, the combined taxation rate that the consumer pays is 36%. That includes a state cannabis excise tax of 15%, state sales tax of 7%, SF cannabis tax of 8%, and a sales tax of 5%. This amount will fluctuate depending on the location of the dispensary. Still, tax rates of 30% and over, generally viewed as deterrents for many consumers, help to prop up the unregulated illicit market that the state desperately wants to terminate. When we return to this model, the profit problem is the primary focus of my policy recommendations.

Three main components have exacerbated the decline of the California legalized cannabis market: overcapitalization and commodification, local control, and taxes and regulatory policies. While they were all siloed with very different decision-makers within each, they have collided to create the perfect storm for retailers. Common sense dictates that most people would not start a business that is structurally proven to lose them money. Most people start companies in fields with strong fundamentals where they can predict profits and losses, such as a convenience store, content with steady profits and growth. Or they enter a risky market with gigantic potential, such as cryptocurrencies, gambling on their ability to strike it rich.

However, cannabis retail is currently a losing proposition in California. Using the profit maximization model, I have observed the current economic challenges of the marketplace, outside of the two most significant externalities: federal legal prohibition and a vibrant illicit market. Below, I have illustrated the process model for opening a cannabis retail store in San Francisco. Several important aspects of this process determine much of the initial capital cost to operators: 

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• Operators must secure a retail location before applying for a San Francisco or state license. While this requirement is potentially waived, it is a crucial cost driver because of location restrictions, which create predatory landlords who raise rates for cannabis businesses.  
• Like many localities, San Francisco requires community improvement work to be done at the store's cost and with input from residents and nearby companies. This paternalistic rule is unnecessary in most other industries, adding time and costs to a struggling sector.  
• Lastly, the local process must occur before state licensing can begin. In this process, companies have been approved for local licensing, which have gone on to be stalled or denied at the state level, adding additional bureaucratic steps, time, and resources that firms do not have.  

City-provided wifi in all City-owned buildings, parks, and transportation.  City buildings, parks, and transportation are located (or travel to) nearly every neighborhood in Oakland. Thus, providing access to free, reliable, high speed broadband service 24 hours per day, 7 days a week  in spaces owned by the City allows for increased access to the most underserved while equitably offering the service in all regions regardless of economic or historical neighborhood status.  This project aligns with the existing OAK Wifi initiative “that provides free internet access for students, seniors, job seekers, small businesses, the underserved, and unconnected.”³¹ Currently, OAK Wifi’s widest coverage available appears to be along the Bart route between West Oakland and San Leandro which means residents outside of this zone must find other means to connect to reliable, high speed internet  In addition, to aligning with City goals of closing the digital divide, this policy will expand the footprint of community anchor institutions³² provided by the City to provide more locations with internet resources to its residents. City facilities such as libraries and recreation centers offer free wifi to Oakland communities onsite, but it is not available in all City-owned outdoor spaces such as parks, golf courses, or stables.  Challenges with wifi instability can be offset by provision of hardwire connections on City-owned property wherever possible.

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The following map shows current OAK Wifi coverage in the green rectangles along the Oakland-San Leandro BART route.  

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On the following map, each black dot on shows the location and potential expansion of wifi coverage/access if made available across all City parks and fields, open spaces, and facilities (including recreation and cultural arts centers, golf courses, pools, stables,etc.)

Conversion of abandoned buildings to city-provided internet cafes.  This policy could provide not only access to reliable, high speed internet but also technology to the most disadvantaged communities.  Furthermore, these unused resources could provide revenue-generating opportunities to reinvest back into the infrastructure in these communities, and a face-lift to the surrounding real estate.  Along San Leandro St., International Blvd., and throughout the City there are a number of abandoned or unused buildings that have remained so for years, some even decades.  In addition to expanding access to the internet and possibly other digital services, transforming these sites to internet cafes could bring improved public safety and economic prospects.  Improved safety would come by way of the community development that the creation of this new community anchor institution would provide leading to consistent public utilization of the facility.  The uplift of the facades of these buildings also uplifts that of neighboring communities, and in turn, encourages the entry of or prospects for small businesses that could benefit from foot traffic.  Many abandoned buildings are already located in areas with business and residential internet connections so much of the infrastructure will be in place for establishing new connections.  Some challenges to this policy may present as time-consuming renovations may be needed.  In addition, confirming Zoning requirements and gaining the proper permits may also slow down the process at the start of the project.

An important subsection of California operators is social equity, which the state has designated as an area of support essential to California’s market. But what is social equity in cannabis, and how does it impact the health and viability of the cannabis market? Often, people refer to social equity as reparations for Black people or charity for individuals affected by the “war on drugs.” Social equity is a process of the government providing certain business advantages to people impacted by the “drug war” and traditionally marginalized in entrepreneurship. This differs from a rural business program for small-town economic growth or women's business programs to increase female ownership.  

The state adopted a light-touch approach in California, allowing cities and localities to determine whether and how they will implement a social equity program. The requirements generally include a residency within specific historically impacted zip codes, income limits, and/or a conviction for cannabis possession. In comparison, there may be more or fewer requirements based on local laws. However, the ultimate goal is to allow state residents to start a business in an industry where they were previously penalized. Opponents of social equity programs have argued that this is a “form of economic protectionism that limits competition and leaves small local operators vulnerable to predatory out-of-state partners and investors.”¹⁴ While I agree that some predictions of local operators being vulnerable to larger, predatory entities are valid, states often tilt the business landscape or regulatory market in a specific direction for various economic, cultural, or social reasons—for example, through the establishment of monopolies in garbage collection, subsidies on crops, or the creation of opportunity zones. California has created laws and regulations to codify social equity as a goal, alongside the health and viability of the cannabis marketplace. Therefore, as we proceed, it is essential to understand that any corrections or improvements to the industry must include the protection of the cannabis market's social equity sector.