PwC Canada's cannabis series

Chapter 8 - Supply chain management

Mastering the mechanics of moving cannabis to market

Since adult-use cannabis legalization, scores of companies have had their business plans put to the test. Within the first weeks of adult-use legalization supply shortages and shipping delays underscored the current market issues. Over the coming months, success for cannabis companies will hinge on whether they can implement a successful supply chain strategy to address all of the initial issues.

The size and expanse of the Canadian landscape and the large distances between major cities make supply chains and logistics challenging for any national business. However, the complexities associated with the nascent adult-use cannabis market – including a patchwork of federal and provincial regulations – will make the coordination of production, warehousing, transportation and retail even more critical for startups in this sector.

We anticipate that effective supply chain management will be a key market differentiator in this new industry.

Those that get their supply chains right have the opportunity to become market leaders, while those that do not are likely to incur excessive costs, miss commitments and lose market share.

Fragile beginnings

Supply chains in the emerging cannabis industry are relatively unsophisticated. Upstream, licensed producers (LPs) have limited experience, having handled only medicinal cannabis to date, which represents just 10% of their maximum target volumes. Midstream, distributors also lack certain capabilities and will need to adapt to a new business model and regulatory environment. Downstream, retailers have had the opportunity to develop more expertise through sales of medicinal products, but their input is limited to the end of the supply chain.

There are four overarching challenges for the industry when it comes to building strong supply chains:

We expect considerable uncertainty in the detailed rule-making processes, affecting not only regulators but also investors, LPs, retailers and consumers. Inter-provincial legislative differences add additional complexity when moving product across borders, similar to challenges the tobacco and liquor industries already face. International sales will likely face obstacles in some countries where recreational cannabis remains illegal.

Producers, distributors and retailers need trial and error to test the market, and it will take a while for the industry to normalize before we see meaningful consumption data.

Financial forecasts for the Canadian market vary significantly, ranging between $4 billion and $9 billion a year.

In response, investing upfront in demand-planning and forecasting capabilities will be critical for all players. Additionally, communication and collaboration between all parts of the value chain will be essential to reduce risk and manage expectations.

All players in the industry must address the technological challenge of integrating systems from seed-to-sale. Companies require clear visibility of process compliance, stock security, inventory control and data capture. Cross-platform, cross-organizational information sharing is not only a necessity, but must exceed the standards that the alcohol and tobacco industries already meet.

Without proper systems integration, companies will be at high risk of non-compliance across the value chain, leading to an increased burden on stakeholders and more public pressure on regulators to enhance and enforce the rules.

It will take companies time to gain experience in handling legal cannabis products. The process will involve trial and error for upstream LPs, midstream distributors and downstream retailers, and business-to-consumer sales will add an extra layer of complexity to service levels. All players will need to understand that unfulfilled service not only means lost sales, but may also cause sufficient frustration to drive consumers to the black market.

In the interim, either under or overproduction could hurt profit margins and may test investor confidence. This lag will also create increased complexity in supply chain planning, affecting product mix calculations, stock and shelf-life management and order fulfillment.

Breaking it down

Each segment of the supply chain will also encounter challenges specific to its role.

i) Upstream, licensed producers should expect supply fragmentation to complicate their planning. Small and medium-sized growers may oversupply the market with generic product, eroding profit margins for all producers. At the same time, requirements for costly track-and-trace technologies could push LPs’ costs up beyond the traditional agricultural model.

ii) Midstream distributors will face the challenge of managing large product mixes, small batch sizes and high fulfillment frequency. The learning curve is likely to prove steep, particularly for provincial regulators that opt to manage a two-tier system of distribution to both retailers and consumers.

iii) Downstream retailers may find their supply chain planning impacted by competition from the black market, which we expect to be strong in the early days of the new marketplace. They will also be challenged by the different rules and regulations adopted by the provinces. Depending on jurisdictional requirements, retail cannabis prices may be set by regulators, limiting sellers’ abilities to respond to market fundamentals of supply and demand.

A lack of knowledge about consumer behaviour, tastes and expected levels of service means operators will need flexible solutions. In these early days of the new market, contracts should be tailored with minimum commitments, strong indicators and multiple renegotiation opportunities.

All stakeholders in the cannabis supply chain will find it beneficial to collaborate and share data and insights, potentially through industry consultation groups or forums.

No supply chain can be perfect on day one, but in the cannabis sector, successful systems must be adaptable, agile and dynamic.

Cannabis producers, distributors, retailers and regulators will be wise to adopt Lean Operational Excellence principles as well as proven performance management techniques, such as key performance indicators (KPIs).

Producers and distributors should also consider involving third-party logistics firms – with specialties in both online and traditional retail – into their supply chain to benefit from their experience and scalability.

Distributors will need to align procurement, material logistics and inventory management through a category management approach to improve planning and reduce idle working capital.

Cannabis companies should be encouraged to implement leading technology to improve both the visibility and efficiency of their supply chains. Potential solutions include:

Barcoding;
Radio-frequency identification tags; and,
Logistics automation systems.

Valuable lessons can be learned from comparable industries, such as pharmaceuticals, that have developed trusted systems for managing and delivering strictly regulated products.

Get it right

The Canadian supply chain experience will be closely watched not only by investors, who have poured billions of dollars into the sector in anticipation of lucrative returns, but also by businesses in other countries moving to legalize recreational use of cannabis, especially those in the United States.