Fluent Essays

1) Conduct an analysis of the general business / macro-economic environment facing Mihi. For each component of your analysis, identify the relevant trends and the implications (positive or negative) for the company. The time horizon for your analysis is 3-years. 2) Conduct a Porter’s 5-Forces Analysis of Canadian Retail Cannabis industry? a. Describe the characteristics associated with each of the five-forces b. For each of the five forces and based on the characteristics you identified in 2a above, identify the level of the force (low, medium, high) along with a rationale as to your assessment. 3) Describe how attractive/unattractive you believe the industry is for Mihi using your answers from #1 and #2 above as evidence to back-up your position. 4) Describe what you believe is the recommended launch strategy for Mihi using the strategy triangle. For each component of the triangle include your rationale for your decision. Read the attached case and answer the following questions in sentence/paragraph form, unless noted otherwise: 1) Conduct an analysis of the general business / macro-economic environment facing Mihi. For each component of your analysis, identify the relevant trends and the implications (positive or negative) for the company. The time horizon for your analysis is 3-years. 2) Conduct a Porter’s 5-Forces Analysis of Canadian Retail Cannabis industry? a. Describe the characteristics associated with each of the five-forces b. For each of the five forces and based on the characteristics you identified in 2a above, identify the level of the force (low, medium, high) along with a rationale as to your assessment. 3) Describe how attractive/unattractive you believe the industry is for Mihi using your answers from #1 and #2 above as evidence to back-up your position. 4) Describe what you believe is the recommended launch strategy for Mihi using the strategy triangle. For each component of the triangle include your rationale for your decision. 1 MĪHĪ CANNABIS: PLANTING THE SEEDS FOR A NEW RETAIL CANNABIS BUSINESS IN CANADA This case was written solely to provide material for class discussion. The author does not intend to illustrate either effective or ineffective handling of a managerial situation. The author may have disguised names and or information to protect confidentiality. In June 2018, the Government of Canada passed the Cannabis Act, paving the way for the legalization of recreational cannabis cultivation, acquisition, possession and consumption on October 17 of that same year1. This move set off a flurry of activity, as existing companies, private equity firms and entrepreneurs sought to establish an initial position within the burgeoning industry. One critical aspect in the formation of the industry would undoubtedly be how cannabis products would ultimately get to the end consumer. mīhī Cannabis, a new-startup, was planning on establishing itself as a key player within this part of the industry’s value chain. Thomas Dyck, the recently appointed CEO of mīhī (Latin meaning “for me”), was busy developing a retail concept and strategic plan he could take to his investors. He knew that the challenge for the company and its competitors would be to establish a strategy that adequately addressed the plethora of external factors influencing the industry and its growth potential. THE CANADIAN CANNABIS MARKET Cannabis (also known as marijuana, pot and over 1,200 other slang terms2) is cultivated from the flowers of cannabis plants. Two of the 113 cannabinoids produced from the flowers of the cannabis plant generate two psychoactive effects when heated or smoked, tetrahydrocannabinol (THC), which is responsible for getting people “high”, and cannabidiol (CBD) which relaxes people3. The cannabinoids present within cannabis are also responsible for the observed medical benefits of the drug, including reduced inflammation, lower blood pressure, improved sleep and the calming of PTSD symptoms3. Cannabis has been used throughout history for both social-recreational and medical purposes. The earliest physical evidence of cannabis use by humans was discovered in 2008 by researchers in China who uncovered a 2,700-year-old Caucasian shaman grave containing 700 grams of cannabis. Notwithstanding this historical popularity, as of 2018, the drug was prohibited in most countries. In Canada, cannabis was made illegal under the Narcotics Drug Act Amendment Bill in 1923. Since then, over two million people have been arrested for cultivating and selling pot. Views as to the rationale behind this prohibition are mixed, with some historians attributing it to a book written by Emily Murphy, published during the same period, that claimed “marijuana turned its users into 2 homicidal maniacs.”4 Regardless, the popularity of cannabis continued to grow in the 1960-70s, resulting in increased arrests for simple possession. In 2001 the Canadian government began a medical marijuana program allowing those with a medical prescription to grow their own cannabis or receive the drug directly from Health Canada until a regulated industry could be developed. At the time, medical cannabis was being used to treat a number of ailments including the pain, spasms and spasticity associated with multiple sclerosis, behavioral improvement in Parkinson’s disease patients, memory preservation in Alzheimer’s patients and tumor suppression and nausea relief for cancer patients. The use of cannabis was also linked to other benefits. In one study, 82\% of respondents indicated they had reduced alcohol consumption, while 73\% had reduced tobacco usage, 86\% had reduced their use of anxiety related medication and 95\% had reduced their use of opiates5. These benefits were in stark contrast to warnings coming from the Centre for Addiction and Mental Health about the negative effects of cannabis6 and a report from the Canadian Automobile Association (CAA) indicating that two-thirds of Canadians are concerned that roads will become more dangerous with the legalization of marijuana.7 Overall, public opinion and the negative criminal stigma surrounding cannabis was changing for the positive. According to a 2016 Nanos Research study, 7 in 10 Canadians were now in favour of legalization8. By 2016 cannabis usage in Canada was strong with 3.8 to 5.2 million regular users expected by 20219,10, approximately 10-14\% of the Canadian population. This expanding base of users increasingly did not fit the traditional, “stoner” stereotype profile often associated with cannabis usage. New users were older, more likely to be married with children and have higher levels of income11. Recreational cannabis was being used for a variety of stated reasons, including: to help relax or sleep (66\%), to reduce stress or anxiety (62\%) and to have fun with friends (58\%)12. Despite changing attitudes, most users continued to hide their consumption from others. This was particularly true for new consumers. One challenge the industry faced was getting existing cannabis users to switch to legalized channels of distribution. Among other factors, existing users indicated they would switch if product quality was better (55\%), there was a range of price points for every budget (54\%), and products could offer a range of potency (47\%)12. Those looking to use legalized cannabis indicated a strong interested in buying from a retail store (48-51\%) as opposed to growing their own (27\%) or purchasing through a website (28-33\%)12. One likely reason for this was the importance consumers placed on knowledgeable in-store staff above other factors, to educate and help them with their purchases. Even long-time, regular cannabis users indicated that their product knowledge was quite limited and would like to learn more. With the establishment of a legal and regulatory framework for the production, distribution and possession of recreational cannabis on October 17, 2018, Canada became only the second nation to legalize cannabis for recreational use. Overall, the market was forecasted to grow to $23 billion, plus an additional $2.7 billion for cannabis edibles, topicals and drinks, which were legalized one- year later13. Given the size of the opportunity, a number of competitors were expected to enter the industry. Competition was predicted to come primarily from 5 different groups. 3 Licensed Producers. These organizations were originally formed to provide medical grade cannabis, as prescribed and overseen by Health Canada. They built facilities to turn cannabis into oil, gel caps and other product types as both a producer and manufacturer of cannabis products. They had access to significant pools of capital, a wealth of product experience, and could take advantage of the economics of full vertical integration. However, given their potential power over the industry’s value chain, it was expected that significant regulatory restrictions would be placed on their ability to establish private retail outlets. Enthusiasts. As there already was an established grey/black market for cannabis across the country, many retail stores existed that actively ignored current regulations and sought to meet the needs of their existing customer base as efficiently as possible. These businesses had access to black market supply, often at significantly lower prices than available through government supply chains. While regulation and compliance adverse, it was expected that these businesses would ultimately transition to legal retail outlets. While being extremely knowledgeable about the products they sold, these competitors had little access to capital or the business acumen to expand significantly. Landlords. Superior retail locations very quickly became the critical scarce commodity within the industry. Because of this, commercial landlords realized that they had an opportunity to stake a claim in the industry. While they controlled key locations, they had no day-to-day experience managing a retail business, particularly one within a highly regulated industry. Private Liquor. In British Columbia and Alberta, private liquor distributors were expected to leverage their existing retail distribution networks and supply chain expertise to get into the cannabis industry in a big way. While they had experience managing a regulated retail business, they had little knowledge and experience with cannabis and the unique needs of the cannabis consumer. Private Retail. The final group of competitors included a mix of firms singularly focused on the retail cannabis market. Some were entrepreneur’s, intent on becoming 1 to 3 store operators, who lacked retail or cannabis specific experience. Others, like mīhī, had access to significant sources of early-stage funding from private equity firms, interested in investing in the sector. The value of these early entrants’ sky rocketed, creating large capital pools which ultimately trickled down to smaller firms. Several were able to leverage their early entrance to amass a significant capital position and build management teams with extensive retail expertise. While opportunities within the cannabis industry looked promising, the overall economic outlook for Canada was less positive in 2018. Strong economic growth over the past decade was expected to subside due to slower employment growth and high consumer debt levels.14 The Bank of Canada was also expected to gradually raise interest rates to offset inflationary pressures, reducing investment stimulus. In addition, there was potential pressure on retail salaries given declining unemployment rates and more generous provincial minimum wage policies. Other economic indicators captured by the company for planning purposes are included in exhibit 8. 4 REGULATORY FRAMEWORK Legalization meant that Canadians could now possess up to 30g of dried cannabis and grow four cannabis plants with licensed seeds or seedlings. However, it was expected that the majority of users would want to purchase rather than grow their own cannabis. In this regard, the Canadian Government, through Health Canada, would control both the quality of supply, through strict licensing of producers, as well as individual consumption risk through regulatory control of the product marketing mix (i.e., significant product, packaging, advertising restrictions). In contrast, each province would be responsible for decisions surrounding the supply chain and retail distribution of cannabis to Canadians. In some markets, municipalities would also be granted authority over whether to participate or decide on the number of retail locations they would allow within their community. This resulted in a complex patchwork of regulations for companies to navigate as they developed launch strategies. In addition, cannabis ecommerce was limited to online purchases made through provincial government websites. While private retailers were technically free to set their own prices, in reality there were numerous pricing constraints at play. First, retailers had to purchase supply at regulated, wholesale price points which effectively set a price floor for all legal competitors. Second, provincial government website prices for online purchases established a price point for legalized cannabis in the minds of consumers. Lastly, black market sellers consistently undercut the legal wholesale rate, establishing a price range for consumers willing to purchase illegal product. The market potential for private retailers was very regionalized. Quebec and the Atlantic provinces chose to utilize their own public, retail liquor networks to sell cannabis, eliminating any private retail opportunity. Alberta, using its experience in privatizing retail liquor decades earlier, chose to permit private retail distribution. However, the province delegated site selection and building permit decisions to municipal governments with mixed results. Some municipalities were quick to establish guidelines, creating an investment frenzy, others chose to opt-out completely, while the remainder established excessive restrictions, making it virtually impossible for private firms to operate successfully. British Columbia was slower to establish regulations, already having a stable grey market (not legal, but not enforced) which they were concerned about disrupting. The guidelines they ultimately established delegated location decisions to municipalities and allowed for only 5 stores per firm. In addition, they also chose to sell cannabis through their own retail liquor network, which would compete directly with the private retail firm’s they were offering licenses to. While most provinces established clear guidelines with minor changes during implementation, Ontario was the most problematic. In early 2018, prior to legalization, the provincial government indicated that it would be using the province’s retail liquor network (the LCBO) for cannabis distribution. However, one day after legalization, the Progressive Conservative Party of Ontario won a provincial majority and quickly abandoned these plans in favour of private retail. For those provinces which allowed private retail distribution, store licensing procedures were somewhat similar. Each firm had to submit an application to the province, which included a non- refundable fee of thousands of dollars per location, and evidence that an executed, unconditional 5 retail lease had been signed for each location. The application also authorized the provincial government to conduct a full criminal and financial check of company officers, directors and large investors. MĪHĪ CANNABIS INC. mīhī Cannabis Inc was founded in Toronto, Ontario Canada, in August, 2018 through a joint ownership agreement between Blackshire Capital Corporation and mīhī’s management group. Thomas (Tom) Dyck, the company’s new CEO, was given the mission of developing a world- class cannabis retail chain within the Canadian marketplace. Tom had just recently retired from a successful 32-year career in banking at Toronto Dominion Bank, where he held senior management positions in a variety of financial business lines in both Canada and the United States. In Tom’s last role as Executive Vice President, Community Banking, he was responsible for the bank’s commitment to deliver a “legendary bank experience to Canadians”, leading 25,000 employees in 1,150 branches. At mīhī Tom would have to create a new organization from the ground up, while navigating significant external hurdles, a nearly 180-degree shift from his experience at the bank. Tom had already recruited some impressive talent for key management positions. His senior vice- president of guest experience was a seasoned, consumer packaged goods and mass market retail executive, and a recognized thought leader in retail innovation while his chief administrative officer, had over 30-years of business and technology experience in highly regulated industries. Other key management positions included a policy guru with previous experience within government regulatory teams in both Canada and the U.S., a product manager with 15-years consumer packaged goods product and sourcing experience and a brand leader with over 20-years’ experience developing some of Canada’s most recognized brands. Initial revenue and cost planning had also begun. In terms of a build-out, Tom estimated that each store would cost between $1 million to $1.3 million to setup, including the initial working capital needed to operate the store. On average, he wanted to achieve a minimum 30\% return on store capital annually. Tom felt that his competitors’ product mix would likely be 80\% cannabis and 20\% cannabis related accessories. Based on the regulated costs of acquiring product from suppliers, his competitors would likely generate cannabis gross margins of 28 - 32\%. Conversely, gross margins on cannabis-related accessories were forecast at 50-60\% and would form the balance of store revenue. Tom firmly believed that a top-tier retailer could achieve a higher gross margin than the industry average through smarter product mix and price management decisions (exhibit 11). Total operating expenses, including lease, staffing and store-related expenses were expected to run between $650 - $800 per square foot. EARLY CHALLENGES The regulatory frameworks established at the federal, provincial and municipal level created significant challenges for early industry development and the conversion of existing cannabis users to legal channels. At the federal level, initial regulations only permitted the sale of plant and oil- 6 based products which represented about 40\% of traditional cannabis usage, leaving much of the market out of reach for industry players. In addition, delays in the licensing of cannabis production, and the regulatory complexity established, created a significant production learning curve, resulting in supply shortages in the first year of legalization. Conversely, the black market offered a full line of products and no supply shortages. The product packaging and dosage regulations imposed by the federal government did not match what consumers were used to prior to legalization. For example, edible products could only contain 10mg of cannabis per package. If the container included five gummy bears (the most popular form), each gummy could only contain 2mg of cannabis compared to the black market which used an average dosage of 15-25mg per candy. At the provincial level, retail licensing guidelines caused a massive “land grab” as competitors realized they needed to secure locations to meet licensing application requirements. Commercial landlords were receiving multiple bids for the same retail locations, and quickly increased their lease rates by 3x – 5x the normal price per square foot, significantly impacting industry business models. In addition, most landlords would not permit firms to break their lease despite the uncertain regulatory environment. This meant that each cannabis retailer had to decide how much risk they were willing to accept, based on the number of leases they were prepared to sign before knowing whether their store license would ultimately be approved. Retailers wanting to operate in multiple provinces faced even greater challenges. For example, each firm had to manage and negotiate with separate supply chains in each province. In addition, store location planning had to consider the fact that overall customer demand, store potential and even the prices consumers were willing to pay appeared to have regional variations. MOVING FORWARD Unlike Tom’s previous roles, here, he was responsible for launching a company in an industry that did not exist as yet. There were few opportunities to learn from others, even in other countries. Both the industry players and the various levels of government were learning in real-time. He knew that he needed to flush out a strategy for moving forward. In particular, he needed to make decisions regarding, which markets to enter and how big a retail footprint to initially establish. While many of the traditional elements of the product marketing mix would be common across all competitors due to industry regulation, Tom knew he still needed to develop a strong value- proposition that would both differentiate the company and support the normalization of the industry in the eyes of the communities in which it operated. His choice of value-proposition would ultimately drive the company’s business model and put greater pressure on certain organizational capabilities over others. Given potential market volatility, Tom knew that conducting a store-profit sensitivity analysis was going to be a critical component to his decision making. The data he had gathered could easily be used to calculate average industry revenue per store, however, these calculations would be misleading, as they did not take into account the vastly different retail formats that would emerge in the industry. For example, Tom expected that mīhī would likely see revenues of 2x the industry average given their larger retail footprint (2,100 square feet), the use of higher-cost, prime 7 locations and the overall marketing strategy he was planning on developing. One area of concern he had was the possibility that market demand would be lower than forecast, while provincial governments might still license the maximum number of stores (exhibit 1). This would result in a reduction in the average industry revenue per store. Thinking about this further, he felt that he could use a 25\% reduction in market demand in his sensitivity analysis to account for this potential volatility. 8 EXHIBIT 1: ESTIMATED MARKET SIZE AND RETAIL STORE POTENTIAL BY REGION 9 EXHIBIT 2: DEMOGRAPHIC PROFILE OF CANNABIS USERS EXHIBIT 3: REASONS FOR USING CANNABIS 10 EXHIBIT 4: FACTORS INFLUENCIAL IN SWITCHING TO LEGAL CHANNELS EXHIBIT 5: PREFERRED PURCHASE CHANNEL 11 EXHIBIT 6: PURCHASE DECISION FACTORS EXHIBIT 7: RETAIL STORE FEATURE IMPORTANCE 12 EXHIBIT 8: KEY ECONOMIC INDICATORS (2016 – 2023) 2016 2017 2018 2019 2020 2021 2022 2023 Growth in Real GDP 1.5 3.1 2.0 1.7 1.8 1.7 1.8 1.8 Consumer Price Index 1.4 1.7 2.0 2.1 2.1 2.0 2.0 2.0 Bank Rate 0.75 1.00 1.73 2.47 2.99 3.00 3.00 3.00 Exchange Rate (US$ per C$) 0.75 0.78 0.82 0.83 0.84 0.84 0.84 0.84 Unemployment Rate 7.0 6.6 6.5 0.6 6.1 5.9 5.8 5.8 source: Conference Board of Canada, 2018 Economic Outlook EXHIBIT 9: MINIMUM WAGE BY PROVINCE 2018 2021 British Columbia 14.60 15.20 Alberta 15.00 15.00 Saskatchewan 11.45 11.45* Manitoba 11.90 11.90* Ontario 14.00 14.35 source: Retail Council of Canada *annual increase based on change in CPI 13 EXHIBIT 10: PRICE WILLINGNESS (PER GRAM) BY REGION EXHIBIT 11: PRODUCT MIX AND MARGIN DATA Industry Gross Margin Product Mix Cannabis 30\% 80\% Accessories 55\% 20\% mihi Target Gross Margin Product Mix Cannabis 35\% 75\% Accessories 60\% 25\% 14 END NOTES 1. Sapra, Bani (20 June 2018). Canada becomes second nation in the world to legalize marijuana. CNN. 2. Steinmetz, Katy (April 20, 2017). Why There Are So Many Different Names for Weed. Time. 3. Brown, Ian (July 1, 2018). “A biography of cannabis”. Globe and Mail. 4. Daniel Schwartz (May 3, 2014). “Marijuana was criminalized in 1923, but why?” CBC News. 5. Merwin, K (January 18, 2018). Eaze Insights: 2017 State of Cannabis Data Report 6. About Marijuana. (2012). CAMH. 7. “Canadians Worry Roads Will Be Unsafe When Marijuana Legalized (November 14, 2016). CAA. 8. Tahirali, Jesse (30 June 2016). 7 in 10 Canadians support marijuana legalization: Nanos poll. CTV News. 9. Skerrit, Jen; Lam, Eric (November 30, 2016). Marijuana producer jumps 356\% as Canadas investor pot frenzy intensifies. The Globe and Mail. Bloomberg News. Retrieved 2 December 2016. 10. Cullen, Catherine (November 1, 2016). Legal marijuana could raise federal cash – but not right away, PBO says. CBC News. 11. mīhī sponsored research (December, 2018), Ipsos Reid 12. Deloitte (2018). A society in transition, an industry ready to bloom, 2018 Cannabis report. 13. Armstrong, Peter (November 27, 2017). Merger madness: Canadas marijuana industry enters consolidation phase. CBC News. 14. 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