Despite early promises of a booming industry with endless potential, the reality for many cannabis producers in Canada has been marked by a struggle to turn a profit. Oversupply, coupled with heavy taxation, black market competition, and evolving consumer demands, has left companies hampered by looming debt bills in a slow-growth industry that requires significant infrastructure investment and strict regulatory compliance.
Against this backdrop, cannabis producers that rationalize their business and balance sheet have the potential to emerge as market leaders.
The high cost of doing business: Top challenges facing Canadian cannabis producers
Which factors have contributed to the current challenges faced by cannabis producers today?
Price compression: Although inflation has caused the prices of many consumer items to soar over the last three years, cannabis products have seen a steep price reduction in the range of 40%. Given the nature of taxation on cannabis products—where the tax is levied on a dollar per gram or milligram of THC—the tax portion has stayed static, while the retail price has dropped. This magnifies the price compression on cannabis producers, who have also faced inflation and cost increases to their supplies and manufacturing expenses.
In an industry struggling to find profitability, the only entities showing real profit are the provincial distributors. Although the government is trying to find a path to fix these models, it may be too little, too late for many cannabis companies.
- Taxes and regulatory fees: Costly excise taxes and licensing fees are squeezing both small-scale operations and established producers as they take an increasingly bigger bite out of their shrinking margins. The federal and provincial governments have acknowledged that a reform is needed, but while the system finds the bureaucratic path to these changes, the balances of taxes owning to the government continue to grow and many cannabis companies are left with no choice but to dig themselves deeper into debt to cover their more critical expenses.
Oversupply: Upon legalization in 2018, the cannabis sector was met with an overwhelming wave of positive hype and a surge of new entrants to the market. These companies had massive valuations, raised huge amounts of capital, and many went public. But this rapid expansion also brought an oversupply of product, resulting in a crowded market underscored by substantially decreased prices and contracted profit margins—in a sector where debt levels were already dangerously high.
“With too many players and not enough customers, the industry is experiencing a massive contraction that, for many cannabis producers, spells liquidity challenges,” says Clark Lonergan, Partner, Business Restructuring & Turnaround Services, at BDO Canada.
- The black market: Black market producers continue to undercut and pose stiff competition to legal producers. According to the Canadian Cannabis Survey 2022, 33% of respondents still turn to the black market, with varying frequency.
Evolving consumer preferences: As both the cannabis customer and the sector continue to mature, Cannabis 2.0 is causing a paradigm shift in consumer preferences, brought on by new cannabis-derived products beyond the traditional dried flower. Although smoking remains the most common consumption method, it decreased from 89% in 2018 to 70% in 2022, according to Statistics Canada, and is expected to drop further.
With this evolution, Canadian cannabis consumers are becoming brand-loyal customers who seek out products that meet their specific needs and preferences.
“Cannabis consumers know what they want and are increasingly buying brands now. You have so many options for what you want to buy and what form to get it in. That's the big transformation in cannabis right now—it’s the wants of those end consumers,” says Lonergan.
Given the numerous challenges confronting the cannabis sector, what steps can producers take to build resilience and rise above these obstacles?
“Liquidation may not be your only option.”
With careful planning and execution, producers who adopt a proactive approach to their business and operations can position themselves as leaders in the cannabis space.
“No matter how desperate the situation, liquidation may not be your only option. The sector has gone through the real downturn and now, there will be winners as it re-stabilizes. You want to get yourself positioned for that next wave of growth,” says Lonergan.
“Rationalize your business and understand your strengths—that's the opportunity right now in this space. But doing nothing is not an option. If you're not proactive in managing it, the likelihood is a liquidation.”
How can cannabis producers plant the seeds of success?
Being proactive means taking stock of and addressing operational and financial deficiencies to lay the groundwork for the next evolution in Canada’s cannabis sector. Consider three ways to accomplish this.
1. Strengthen your balance sheet
A balance sheet restructuring can be a complex and multi-faceted process that requires careful planning and execution—but when done correctly, it can help a company to improve its financial position, enhance its ability to generate profits, and achieve long-term success.
According to Lonergan, “business owners should ask themselves: do they have the balance sheet—either the equity, the cash, or the access to debt—to grow and weather the storm? For many companies, surviving this downturn will have to do with balance sheet restructuring and access to capital for that next wave of growth.”
2. Find your niche
As Cannabis 2.0 gathers momentum, there is opportunity for innovation and the capture of new revenue and market segments, from royalties and genetics programs, to developing sought-after strains of cannabis. Understand which vertical market you want to participate in and have a product differentiation strategy in place that supports it.
3. Manage your narrative
Be proactive in telling the right narrative to your stakeholders, knowing how much and what information to share.
“It's an upfront cost to be proactive, but when you're reactive, the value-add normally goes down and the costs go up because you lose control of the narrative,” advises Lonergan.
How BDO can help cannabis producers catch the next wave of growth
Our professionals in Business Restructuring & Turnaround Services (BR&TS) have worked with cannabis producers to re-position their businesses for long-term success in the rapidly evolving industry. We can provide clarity into your operations with an in-depth strategic options analysis that defines your core strengths, identifies underperforming or inefficient areas, and uncovers new revenue streams.
“With Cannabis 2.0, there is so much opportunity to diversify the product offering, and as end-consumer preferences evolve, we can help cannabis companies focus on what matters,” Lonergan says.
Depending on your unique goals and factors affecting competitiveness, our BR&TS team can conduct a comprehensive balance sheet restructuring and advise on options that make the most sense to your business, from selling off unprofitable divisions or geographies, to developing a balanced capital structure that empowers you to weather changes in the industry.
As the industry continues to evolve and mature, some cannabis companies may need to wind down their operations for various reasons. BDO Canada has the expertise and experience to help these companies navigate the complex process of liquidation, including managing the sale of assets, negotiating with creditors, and complying with regulations.