Economy of Scale – The cost advantage that arises with increased output of a product. Economies of scale arise because of the inverse relationship between the quantity produced and per-unit fixed costs; i.e. the greater the quantity of a good produced, the lower the per-unit fixed cost because these costs are shared over a larger number of goods. Economies of scale may also reduce variable costs per unit because of operational efficiencies and synergies. Economies of scale can be classified into two main types: Internal – arising from within the company; and External – arising from extraneous factors such as industry size. – “Investopedia”
I am constantly asked “how can I expand my cannabis business across state borders?” I am then forced to explain how the U.S. system of federalism works. Even though medical and/or recreational use of cannabis may be legal in your state, it is not legal on a federal level. Why? This boils down to the same issue concerning banking for the cannabis industry – the Schedule I Classification of cannabis makes its possession, use, cultivation and/or sale a federally illegal activity. Then logically following, from a federal perspective, the proceeds of activities involving Schedule I “drugs” are the proceeds of illegal activities.
Constitutional law then forces us to examine two important issues – (i) Preemption and (ii) Interstate Commerce. The “Supremacy Clause” states that state laws which conflict or contradict federal law, are null and void. Federal law is therefore the “law of the land”. So in essence, all state legalization of cannabis, in any category, will not be “legally” recognized by the federal government with respect to law enforcement. These real battles are being fought every day in states that have legalized cannabis use. For the moment, the federal government seems to content to allow the great cannabis experimentation to continue, while occasionally issuing “safe-harbor” guidance that is quickly disregarded.
Now to focus on the Interstate Commerce clause, since cannabis is not legal under federal law, cannabis cannot be transported across state lines. To do so is a federal crime. So a cannabis business may have several locations or grows, as permitted under state law, be there is no legal way for cannabis to be shipped or sold across state lines.
But what if I am an edible producer in California that wants to sell my brand in Colorado? There is a way. But not by traditional franchising.
Generally, in a non-cannabis business, such as a restaurant, one would enter into a franchise agreement. The franchise agreement would allow the corporation to transport its food product from one central location, let’s say in Arizona, to all of its franchisees across the US. So French Fries produced in Arizona are then shipped to California, Texas, Nevada, Colorado. The costs to do this become cheaper, and the profit to be made greater, because the company can take advantage of the economy of scale with more franchisees One factory, one work force, simple accounting, in one consolidated center lowering overall costs. There is also a consistency of product issue. What the fries taste like in Arizona, should be exactly what they taste like in California. But cannabis businesses cannot take advantage of economies of scale across the US, as of today.
The solution to the cannabis business’ problem, is not difficult, but is simply more expensive and resource intensive. By using Royalty/Consulting Agreements, you can either partner up with an existing cannabis business or create your own in the different state. You will be leveraging your formula, recipe, branding and expertise. A new kitchen will have to be established in each new state. New vendors providing cannabis, of the same strain, potency and quality will need to be found in each and every state to replicate the original. Not as easy as it sounds.
The business owner will receive a percentage of profits, as well as a monthly consulting fee, for the use of its formula, recipe, expertise and marketing costs branding the product. This is certainly not the best “economy of scale” solution, but for today it appears to be the only solution for profitably expanding your cannabis brand across state borders.
Eventually, once cannabis is reclassified from Schedule I, the prohibition on shipping it across state lines will end, and thereby will allow cannabis franchises to arise on a national level – just like a McDonalds. When that day comes, cannabis business owners and the cannabis using public will be loving it! In the meantime, Royalty/Consulting Agreements are they one way to have a multi-state presence.