The Cannabis Column

Marijuana laws have been, are and always will be about the market. The problem with public policy is that it has been focused on the myth of availability rather than the reality of profit. Marijuana is available because it is profitable. Regulation of the profit regulates availability.

Marijuana advocates have long argued that powerful forces favor prohibition because of financial interests. This is mostly true, in that the regulation of market entry is one of the five forces that affect the profitability of any industry. However advocates – and opponents for that matter – must realize that having influence over availability is what drives public interest in marijuana laws. The public has been led to believe that prohibition reduces availability in general and especially availability to teenagers and children. One of the keys to ending opposition to legalization is addressing concerns about availability by examining the issue of profitability.

Five forces determine the profitability of any industry. Harvard Business School Professor Michael Porter devised this framework for understanding modern markets and for developing business strategy. Porter’s five forces framework is the subject of several books, a multitude of articles and a standard material in most management and business school studies. Michael Porter describes his framework in this YouTube video. The five forces are: market entry, competition between rival firms, substitute products, suppliers and consumers.

Most discussion about the marijuana market focuses on the impact of prohibition, which is essentially an attempt by the government to regulate market entry, and how the resulting illegality of the market impacts availability through raising the price of the commodity. At least that is the modern argument – the illegal nature of the product keeps prices high and consequently discourages use. Originally prohibition rested on the premise that making marijuana illegal would prevent people from buying it.

In fact, prohibition raised the price of marijuana, creating an incentive for people to enter the market. Indeed, according to the National Survey on Drug Use and Health 769,359 teenagers sold illegal drugs at least once in 2011. Since marijuana is the most popular illegal drug, it is likely that most of them, if not all, sold pot. Overall, more than 3.9 million people sold illegal drugs in 2011. Clearly prohibition of illegal drugs does not prevent market entry; it just makes drugs more expensive.

The common argument is that prohibition makes marijuana more expensive because merchants inflate the price to cover the risk of arrest – a tax of sorts to compensate them for the danger of being involved in an illegal market. Actually, prohibition keeps the price of marijuana high by reducing competition. Marijuana prohibition is a price support mechanism that allows merchants to charge artificially inflated prices. The immorality of prohibition is that government policy intentionally produces a market in which extensive profits are generated for the limited number of market participants. Listen closely to the arguments in favor of prohibition. High prices discourage use, that’s the rationale for keeping marijuana illegal. Understanding marijuana as an economic market is the key to changing public policy. It is also the key to making money in the emerging legal marijuana market produced by state level reforms.

Here is how Porter’s five forces provide clarity to understanding the dynamics of the marijuana industry. Start with the indisputable premise that marijuana is profitable and will be produced and sold. A merchant makes a profit on the sale of marijuana. This has been, is and will be true. The real question is who gets the profit, or more precisely, what forces affect how much profit is made by those participating in the market. 

Most people think of profit as a function of competition between rival merchants and their ability to reduce costs, increase price and increase sales. This is basic economics. However Porter points out that, with respect to creating strategy, the five market forces all determine the profitability of a particular industry.

Strategy is a matter of creating a sustainable competitive advantage. Each of the five forces works to reduce profits. Newcomers to a market want a share of the existing profits. Suppliers want to charge higher prices, increasing their share of the profits. Consumers want lower prices, which is their way of trying to grab a share of the profits. Rivals compete over market share. And the makers of substitute products try to divert profits from popular merchandise to their alternative. Strategy is a matter of protecting profit from each of these five forces. In any market some (or all) of these forces are dominant, and as such have greater or equal impact on profits.

Traditionally market entry, influenced heavily by prohibition, has been the dominant force determining the profitability of the marijuana industry. This force is also a factor in medical marijuana businesses’ recent opposition to making pot available to all adults. After all, increased competition will lower prices and lower their profits. 

Over time the other forces have begun to gain more influence over the marijuana market. Consider the impact over the last several decades of indoor pot cultivation. This represents an increase in the impact of suppliers (with respect to commercial cultivation) and also that of consumers (when it comes to personal cultivation). Think about the interests of the alcohol industry and their reputed opposition to marijuana’s legalization – in this framework marijuana is viewed as a substitute product for alcohol. Consider the emergence of synthetic marijuana. This is an example of a substitute product trying to capture a share of the profits in the marijuana market.

Marijuana law reform is a consumer rebellion against government price supports created and enforced by restricting entry into the marijuana market. Regulating the availability of marijuana should and can be done by way of age limits, rather than through the protection and preservation of illegal, untaxed and underserved profits.

Arguments for expanded legalization aside, the five forces framework provides a rationale and instructive perspective on the changing dynamics of the marijuana industry. Porter’s framework provides explains competitive dynamics, public policy disputes and the rapidly changing environment for capital investment. Anyone who wishes to succeed in the new cannabis marketplace will benefit from learning more about Porter’s five forces and their relationship to corporate strategy.