The Herb Column: Competing With the Underground Market

Licensed operators say they’re barely holding on as their market share gets eaten up by illegal sellers

Back Web Only Jan 25, 2019 By Steven Yoder

It’s New Year’s Day, and Chelsea Cordoba is at the office. She and her husband, Kenneth, run Mountain High Recreation, a licensed cannabis delivery business in East Sacramento. They work 7-day weeks and 16-hour days, and have sunk most of what they have into the business they founded in 2017 — the stuff of startups everywhere in competitive industries.

But in this sector, the thriving black market makes this competition something like playing hoops against an opponent with extra players on court. Mountain High pays hefty taxes, licensing fees and attorney bills, and keeps a compliance consultant on retainer, all of which adds up to getting undercut on price by 30 to 40 percent, says Cordoba. The couple are parents of two small children, and Cordoba says while the company’s future is bright, “we’ve held on by a string sometimes.”

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A check of the cannabis locator platform Weedmaps, which doesn’t require operators to have a legal license to post on the site, confirms what Mountain High is up against. A search turns up 20 delivery businesses in south Sacramento, where law enforcement has often shut down unpermitted deliverers and growers in the past. Only nine of the 20 have a state permit, according to the state’s Bureau of Cannabis Control. The status of two others is unclear because of a possible error in the BCC’s licensing search system, says BCC spokesperson Aaron Francis. The remaining nine are running without a permit. (None of these last nine responded to requests for comment.)

Jerry Chin of Humble Root, one of the nine legal licensees, says his own search of the metro area on Weedmaps turns up about 150 unlicensed delivery companies. He says those companies are beating his prices by about 50 percent on average.

The underground market is flourishing in Sacramento and across the state. The BCC and city have promised a crackdown. But there’s disagreement in the industry about whether that’s the right move.

Proposition 64 was supposed to bring marijuana sellers and producers out of the shadows —  dispensing with prosecutions would remove the incentive for illegal operators to deal on the sly. The end of the illegal market still may come to pass, but if so it looks years away. Last August, industry analyst New Frontier Data calculated the size of the state’s illicit adult-use market at $3.3 billion, five times that of the legal one. Now the state says it’s ramping up enforcement. In 2018, the BCC’s focus was getting through the temporary licensing phase, but in 2019 that will shift toward shutting down unlicensed businesses, it says.

To that end, the agency is launching a messaging campaign in part targeting underground players. “For those illegal operators, the picture is, ‘We know you’re out there and operating and we need you to get a license because we know where you’re at,’” says BCC spokesperson Alex Traverso. “Hopefully, they get the sense that the walls are going to start closing in and that they’re not going to be able to operate the way they are now forever.”

When the agency learns about an illegal business, it issues a cease-and-desist letter. “It basically says, ‘You don’t have a license, here’s how you go about getting one and here are some of the penalties if you don’t,” Traverso says. Statewide, the BCC has issued about 2,600 of those letters, he says. (The agency has no data on how many have complied as a result.)

As for the City of Sacramento, it’s already several months into a squeeze on illegal indoor growers. Joe Devlin, Sacramento’s chief of cannabis policy and enforcement, says the city at one time had about a thousand of those. But after a wave of arrests by city police — at least 70 according to city records — the number of illegal grow houses is down to perhaps 400, says Devlin.

Devlin is promising more where that came from. In a November presentation at an agency meeting with cannabis stakeholders, he warned businesses that weren’t moving to get their temporary state permits. “Those folks that don’t have this temp permit to operate after Dec. 31, we’re going to be taking a very hard look at … who is operating and who is not, and matching up those folks who are operating with who has a state permit,” he said. “And [for those who don’t], we’re going to be having the conversation of, ‘What time today are you closing down?’”

The industry itself appears split on whether better enforcement will actually bring more of the operators into the open. Chin says the city and state agencies have lived up to their promises on the regulation side of the ledger but not the enforcement side. “Not dealing with these [enforcement] issues aggressively enough might cause Prop 64 to fail,” he says. In January came a report from the California Cannabis Advisory Committee, an agency tasked with making recommendations to regulators. (About a quarter of the agency’s members work in the cannabis industry). The committee concluded that state agencies initially took a “slower than expected approach to enforcement” to give businesses time to come into compliance. “Lack of enforcement is creating a thriving environment for the unregulated ‘underground market,’” the committee wrote.

Steven Domingo of the California Cannabis Courier Association doesn’t think more focus on shutdowns and arrests will work. He says exorbitant market-entry costs, in part levied by government, are keeping small businesses underground. Sacramento, for example, charges about $17,000 to $34,000 for a conditional use permit and $2,600 to $31,000 for a business operating permit, depending on business type. Add state license fees, various insurance premiums, attorney fees and other costs, and many operators need $250,000 to step into the daylight, says Domingo. And that’s all before a tax burden that runs more than 35 percent all in, according to the advisory committee.

Zachary Pitts of the CCCA says many delivery businesses are small family-run enterprises that have been around a long time but can’t come up with the upfront investment required to go legal because they have trouble raising money, particularly in an industry without access to banking. “Everyone we talk to in non-storefront delivery… they’re all interested in getting licensed,” he says.

For those that are legal, their success rides in large part on consumers knowing the difference between licensed and unlicensed dealers, and choosing safety and reputation over price. Gov. Gavin Newsom’s budget reveals that the state is bringing in only about half the taxes that were projected from legalization, largely because consumers are continuing to buy from illegal dealers, according to experts interviewed for a January Associated Press report.

To that end, Traverso says the BCC is launching a public awareness campaign starting in late January to direct consumers to legal operators and make them aware of the public-safety risks — like potentially high pesticide levels — in untested products bought from unlicensed dealers.

As for Sacramento, Devlin says there’s been talk of coming up with some kind of city-issued seal or emblem that licensed operators could display to differentiate themselves. (Mountain High Recreation lets customers know that they’re legit by posting their state license number prominently at the top of their home page.)

Weedmaps and similar platforms also might help by refusing to let businesses without permits post on their sites. The company didn’t respond to multiple inquiries about the reasons for its apparent policy of letting unlicensed businesses advertise. Last March, the BCC issued a cease-and-desist letter to Weedmaps for “aiding and abetting in violation of state cannabis laws.”

One start in the direction of incentivizing compliance might be a tax relief package. But a bipartisan plan to reduce taxes failed last spring in the legislature, and a second was vetoed by  then-Gov. Jerry Brown in September. “The way you end [the underground market] is to create a competitive market that squeezes it out,” Domingo says. “You don’t see moonshiners anymore — alcohol is so readily available and at such a cheap price that it doesn’t make sense to have a black market.”

Comments

Lou Anne McKeefery (not verified)January 25, 2019 - 3:13pm

We don't hear farmers saying they cannot compete with home gardeners who offer excess tomatoes to their friends. The problem is not the illicit market, the problem is the unrealistic tax grab the state and city are putting on the market as is stated at the end of this article.

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