Mexico’s Looming Cannabis Boom

Conversation around the opportunities around Cannabis legalization is getting heated, especially after measures to legalize it won major victories both in the US during election week as five states — Arizona, New Jersey, South Dakota, Montana and Mississippi — legalized some form of marijuana use, and more recently in Mexico as lawmakers passed legislation after decades of restrictive drug policies that fueled deadly cartel wars. Both these measures poise Mexico to become one of the biggest legal cannabis markets in the world.

The better poised players to go into the space would be the already established Mexican and North American high-quality, specialty vegetable growers, which already have some sort of facilities and expertise, like it already started to happen in waves across the US and Canada and will continue more aggressively as legalization gains more momentum. What does it entail to make the move towards this new (legal) industry? And more importantly, what would this mean for growers that stick to growing vegetables despite this newly minted opportunity?

Naturally, a lot of entrepreneurs and investors are eager to enter the space, and caution should be advised. I’m not saying that cannabis doesn’t have the potential to be a great business, it can, but there’s a lot of factors to be taken into account by both investors and entrepreneurs so not to oversimplify a business that is a lot of things but simple.

First, I’ll go through the main challenges to be faced by a newly born legal cannabis industry:

REGULATION

We need to look into what is actually going to be legalized and when; business scale and liberty to operate depend on this strongly. Usage can be legalized in various forms but what about production and distribution? The next question would be licensing. How many licenses will the government approve and how often? One can hope this process will be flawless and efficient, but reality tells us most government processes in Mexico are not. Even in the US, many cannabis businesses face brick walls, even in states that have legalized and regulated production and sale. This hurdle can be a business-killer when operating in a seasonal and capital-intensive industry. Cannabis legalization is not a binary switch. Finally, taxation. Special and cumbersome taxation for the industry would be a very important matter to take into account in a business plan.

OVERCROWDING

To put this in context, last fiscal year, US Customs and Border Patrol seized 266,882 pounds of marijuana, down from 4.3 million pounds in 2009 coming from Mexico, which means demand is being met, predominantly by new players in Canada and in the US states that have legalized its use. For example, the CBD market is flooded with some 1,500 brands jostling for market share, according to cannabis research firm Brightfield Group. The flooded market is a result of entrepreneurial enthusiasm for a booming trend with few established brands. Throughout 2019, the CBD market saw so many new CBD market participants that those earning less than $1 million in annual revenues occupy over 97% of the market. The same is happening with players targeting to produce high quality, specialty bi products for the pharmaceutical industry.

Expect steep competition across national and international fronts. The craze is real. Mexico entering the space as whole, with better labor costs and climate, will further flood the space and put further strain on supply. 

PRICE DYNAMICS

We already talked about how legalization essentially overcrowded the space in the US and Canada, and it will surely be the same in Mexico. Going back to basic economics, a steep increase in supply will push prices down and, therefore, any player will have thinner margins and a hard time breaking even. Systemic disadvantages remain for the state-legal industry on numerous fronts, which translate to inefficiencies and costs for businesses and consumers. 

With retail outlets closing their doors around the world, it has made it persistently difficult for a lot of brands to be able to scale and to reach their ambitions. And it really favors the larger brands in the market. Moreover, macro cultivators are able to sell their products at wholesale rates. Smaller players can’t.

Sure, Mexico’s climate and labor costs make a much better case for production than the US and Canada but, what about know-how?

GROWING TECHNICALITIES

Ok, so the numbers look great, but the real question to ask is if the venture has the technical expertise to actively and correctly operate around daily changing climate conditions and an ever-changing living crop. I’m talking about ventilation and air circulation, soil additives and nutrients, temperature and humidity, lighting, etc. Without flawless execution on these fronts, minimum quality and yields can’t be achieved and, therefore, you wouldn’t even have a product to sell and no bottom line. Not to mention that after that logistics, distribution and actually having customers for the product are the next hurdles. Cannabis is very tricky to grow, especially because it needs a very specific climate to thrive and the crop’s timing is crucial with the sprouting of the plant’s flowers.

Any grower can tell you that growing anything on a large scale is extremely difficult and requires vast technical knowledge and talent. New players might think that when speaking about agriculture, technology IS the business and that couldn’t be farther from reality. No amount of technology will give you yields and quality; technology is incremental only on top of a sound, solid operation with robust teams and technical knowledge across areas. If you don’t have that, technology won’t matter at all. Technology for technology’s sake companies might work in some way in other industries, but not in agriculture. There’re numerous examples of companies across the world dealing with different crops that have all the latest high-tech tools and still lose money. I’ve seen enough examples of entrepreneurs expecting technology to sail their business to success and ultimately finding themselves in real trouble. 

Agriculture is a very capital-intensive business where you can lose a lot of money very fast when operating below the break-even level.  Legal cannabis, particularly in Canada, has been struggling under the weight of burdensome regulations, poor supply-chain management and quality issues.

ILLEGAL COMPETITION

Everyone in Mexico knows that if someone wants marijuana, they can get it fairly simply, illegal or not. How can you compete with players that don’t need to worry about a slew of costs, dealing with regulation, proper incorporation, corporate governance, minimum wage, social security and taxes? Legal cannabis is inherently more expensive. One needs to think about what the differentiator is if the illegal one is as easy to get, and cheaper. Exportation or by-products? What happened in Canada is a good example. As regulators fixed prices, legal players became less competitive because their dark counterparts and illegal product were never displaced.

Another problem, and an intangible one is what would be the reaction of criminal groups profiting from these industries against the newcomers. First movers will find out for sure. Some people say that marijuana traffickers will simply find new illegal ventures. Mexico's cartels have already been diversifying into human smuggling, fuel theft and agricultural industries such as the avocado trade (most often by force).

Like in any business, it is easy to simplify. Just do whatever the other guy is doing. Especially when being surrounded by a craze and fear of missing out.  Like investment bankers often say – an Excel model can stand any assumption. What ultimately needs to be reckoned is the actual day to day reality of a very complex and unforgiving business model.

Going back to one of my questions earlier - The more interesting result stemming from this whole movement will be though, that more and more cannabis producers in North America are starting to migrate already existing greenhouse space towards growing cannabis instead of specialty vegetables. While the majority of licensed producers in Canada grow cannabis in an indoor setting, there are a growing number of secure greenhouses of all sizes being approved for production. Greenhouses offer a smaller carbon footprint, and also offer a decrease in operating costs, by some estimates up to 90% lower hydro/electrical costs, making them very attractive for Cannabis operations.

 This dynamic will make specialty vegetable growers scarcer across North America, and that market is getting all things but smaller. For the market to cover existing demand with fewer players, prices will have to move upwards benefiting the growers that do stick to it handsomely. I would argue that there is no better time to grow high quality specialty vegetables than during this cannabis boom, especially if Mexico goes all in. Hidden opportunities always arise on the sidelines of the obvious ones.