Value Creation for Consumer Goods in Cannabis
In an age where the traditional Fast Moving Consumer Goods (FMCG) industry is dealing with slowing growth rates driven by disruptive trends, the cannabis industry is just getting started. This means that the age-old model for value creation for mass-market FMCG brands is alive and well within cannabis — and those disruptive trends that have decimated growth for traditional FMCG are the same ones accelerating growth for cannabis. This is great news as both looking at what has worked so well in the past presents new opportunities for the future combined with harnessing many disruptive trends as a driver for this new, dynamic category. If you are operating a cannabis brand, or considering entering the space, here is what you need to know.
Cannabis is one of the fastest growing consumer goods categories with estimated annual sales in North America approaching $20B for 2021, and on track to close in on $40B in sales by 2025 according to Headset estimates. Cannabis is an industry with 20%+ CAGR, and that’s likely on the conservative side. With east coast legalization upcoming and federal positioning changes on the horizon in the US, we could see those CAGR numbers reach nearly 50%. Contrast that with traditional mass market brands, whose 40 years of outperformance slowed in 2010–2018 to rates of 3.2%.
What’s old is new again
The playbook for FMCG was perfected shortly after World War 2 and continued with a lot of success in the decades following. Only recently has FMCG found that this playbook is being disrupted by emerging trends, the same trends that propel the cannabis industry. This slowing growth is the result of several disruptive factors, some of which are built into the growth story of cannabis, such as Millennial/Gen Z preferences and a digital-native approach. Within cannabis, we can dust off this tried-and-true playbook in its relatively underutilized form, incorporating those same disruptive trends into a strategy that wins.
So what is this playbook? McKinsey defines the strategy in five core areas.
- Perfected mass-market brand building and product innovation.
- Built relationships with grocers and other mass retailers that provide advantaged access to consumers.
- Entered developing markets early and actively cultivated their categories as consumers became wealthier.
- Designed their operating models for consistent execution and cost reduction.
- Used M&A to consolidate markets and create a basis for organic growth post acquisition.
With these five aspects in mind, we will explore the untapped opportunity and identify areas that may be challenging in this unique category. Each one of these sections will be supported by more extensive essays to come, but I want to touch on each in general terms.
1. Perfected mass market brand building and product innovation
Cannabis has yet to deliver a brand that is synonymous with mass market. Ask anyone what their favorite cannabis brand is, and most likely their answer will vary if they are in Seattle vs San Francisco vs Boston vs Detroit. There is plenty of opportunity to create a ‘White Claw’ or ‘Anheuser-Busch’ of cannabis, a brand that is first to mind when people think about cannabis products. To do this effectively will require a brand to be able to scale across state lines through third-party licensing structures or holding cannabis production licenses directly, or a combination of both. With traditional digital advertising avenues like Facebook and Google not allowing cannabis content, it also requires exploring unique marketing channels to attract that broad consumer. Cannabis is an incubator for product innovation, with almost blue sky opportunity to create new product formats, potency, cannabinoid and terpene makeup, extraction methods, and more.
Wana is a great example of a brand with extensive market reach. Wana is available in over 11 markets across medical and adult-use, in both the US and Canada through a combination of direct production and distribution partners. This means in markets like Colorado, where Wana is based, they are producing their own products, where in markets like Canada they work with the Canadian LP Indiva for distribution. To accelerate brand awareness even further, they leverage Wana Wellness, a nationally available CBD brand which provides cross-channel awareness and acts as a further accelerant to mass market positioning.
2. Built relationships with grocers and other mass retailers that provide advantaged access to consumers
The FMCG world has tried and true methods for developing strong relationships between retailers and vendors that cannabis can take advantage of. Some examples include creating a collaborative relationship through vendor managed inventory, a generally underutilized program in cannabis that can create strong alignment of incentives between retailer and brand. Other opportunities like co-marketing and promotion efforts to attract repeat purchasers, developing preferred placements in-store or within the retailer’s web experience can drive further success. Building programs like this may be challenging at scale, given the fragmented nature of retail, but many technology-forward solutions are beginning to emerge that may help with many of these common relationship building initiatives.
Working closely with retailers to sync on discounts and promotions can be helpful to build strong relationships with retailers. In the above chart, you can see an example of Kiva the top-selling Edible brand in California for total year 2020. Notice how they were under market averages in April (4/20 a common cannabis holiday) but were discounted more significantly than market around the holidays in December. Often retailers will discount on their own accord, but collaboration between retailer and product manufacturer on discounting and promotion can align interests strongly.
3. Entered developing markets early and actively cultivated their categories as consumers became wealthier.
For the cannabis industry every market is developing at the moment, even those that have had adult-use cannabis programs for a number of years like Colorado or Washington. New products and brands are being introduced at a steady clip, unparalleled in the traditional FMCG space while consumer preferences have yet to be solidified.
Cannabis sales skew towards a younger demographic. Already 10% of cannabis sales are going to Generation Z, which is really only three years of legal age in the US: 21, 22, and 23 year olds. As this generation continues to build their earning power, they will begin to build wealth and have more disposable income and less price sensitivity.
4. Designed their operating models for consistent execution and cost reduction
Any business in any category needs to be focused on consistent execution and cost reduction. Often organizations leverage a strong infrastructure of services to build efficiencies to help with both those aspects. The infrastructure for cannabis is just now being developed by a set of new ancillary service providers dedicated to the cannabis vertical, primarily driven by two key factors. First, certain aspects of cannabis that are unique to the category such as growing conditions and strain diversity, as well as extraction and infusion methods required. Second, given cannabis is federally illegal many organizations that might be able to support consistent execution have limited options from traditional service providers. This translates into the benefit of establishing best practices and building on top of a modern tech stack without any of the legacy hang-ups found in traditional verticals.
5. Used M&A to consolidate markets and create a basis for organic growth post acquisition
The M&A opportunity in the cannabis space is wide open. With the explosion of new markets opening and new licenses being issued, we are seeing a similar explosion of brands and products. At Headset we track over 500,000 individual products within 11 different regions, spread across over 5,000 distinct brands.
With so much brand diversity, new brand introductions can rocket to the top of best seller charts quickly and are great targets for M&A opportunity. In fact, we see the common pattern of the Pareto Principle in effect where 80% of activity is driven by 20% of participants. To illustrate this, in January through November 2020 in the California adult-use market, the top selling 20% of distinct products sold generated 81.04% of total sales. The other 80% of brands are great targets for M&A. Finally, consumer co-purchase behavior shows that people are buying multiple brands across different categories highlighting consolidation opportunities to create baskets commanded by a single brand or organization.
The Disruptors
When looking at growth opportunity for traditional FMCG, McKinsey highlights a number disruptive trends that have a negative impact on the traditional CPG industry. I would argue that these same disruptive trends provide an accelerant to the traditional playbook, as cananbis is an industry that has the benefit of no legacy practices. The disruptors act inversely, almost like a turbocharger to accelerate success vs. a negative in traditional FMCG categories.
Disruptors as accelerant
These disruptive trends include things like the millennial effect, digital intimacy, explosion of small brands, better for you products, e-commerce giants, and rise of local competitors. In almost all cases, you can see these forces being played out in real-time in the cannabis sector. For example, the millennial effect states that younger generations prefer newer brands. In cannabis, everything is a newer brand, with all brands in their infancy and the fact that sales skew towards millennials and generation z will accelerate the support of newer, smaller brands as they grow into large mass market brands.
The playbook as opportunity
For those already in the cannabis space, or looking to enter with imminent federal legalization it’s time to dust off that old playbook and track your performance against tried and true methods, colored by disruptive trends and the unique opportunities and challenges intrinsic to cannabis. In future essays I will do deeper dives into the five areas within the playbook, as well as look at disruptive trends all grounded in data.
At Headset, our mission is to deliver organizations the analytics they need to drive informed decisions, ensuring their success and at the same time, ensuring the success of this nascent industry. There is so much opportunity in cannabis, and the field is wide open. There has never been a better time to jump in, and I look forward to seeing how these trends play out over the years to come.
