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Industry Report: Scaling Cannabis Manufacturing

by Eric Peterson on June 11, 2018, 03:44 pm MDT

In both Colorado and California, entrepreneurs have realized that cannabis manufacturing is not only one of the hottest economic sectors of the 21st century, but also one of the trickiest.

Manufacturing with cannabis can be like playing Whack-A-Mole. When you hammer one problem, another pops up.

There are regulatory issues on the state and city level. There are much bigger problems on the federal level. The supply chain is not established, and many companies don't want to do business with cannabis companies. It's difficult to scale up to meet demand, and even harder to scale across state lines.

The green rush is starting to look like the gold rush. It's better to sell picks and shovels to the miners than dig in the hills yourself.

Joe Hodas, COO of Denver-based General Cannabis Corp., worked for Dixie Brands from 2014 until early 2018 and saw its fortunes rise and fall more than once.

In January 2014, the advent of recreational cannabis in Colorado led to a "tidal wave" of demand for Dixie's products. "Most companies, Dixie included, went into 2014 with the best effort to have inventory and be ready," says Hodas. But it was difficult to gauge exactly how much and what customers would buy.

Dixie saw demand for products spike 500 to 1,000 percent "overnight," says Hodas. "To have enough inventory was virtually impossible."

The company soon had trouble sourcing packaging and plant material. "Within a couple of months, we ran into supply chain issues," says Hodas. A backlog developed. "At times, it got to be more than $500,000 in backlog demand. Our market share tanked," he says. "We began to crawl out of it, then another issue hit."

His big takeaway: "The winners aren't necessarily the companies with the best product or the best brand, but those who can keep supply on the shelf."

It's the reality of manufacturing with cannabis. Beyond the elephant in the room of federal prohibition, there are a host of smaller animals to contend with in Colorado, California, and other legal-cannabis states. On the federal side, FDIC and cannabis don't mix. "Banking is an issue," says Hodas, describing a snowball effect. "Company A can't pay company B, so company B can't pay company C." There's also a lot of hype. "There's so much noise and smoke and mirrors you need to cut through," says Hodas.

He says Dixie's licensees in new markets benefited from lessons learned in Colorado. "All of those pieces of information helped prepare other markets we launched with Dixie." Similarly, with General Cannabis, Hodas says he plans to help other companies avoid some of the pitfalls he encountered with Dixie, with verticals in security, apparel, manufacturing consulting, and investment.

Another bit of wisdom from Hodas: Keeping a narrow focus on a category helps, like Wana Brands and its gummies. "Don't day one launch with 27 different products and 27 different packaging platforms," he says. "Start small and have greater focus. Dixie did not have flexibility. That company [Wana] continues to build market share."

Learning the hard way

"I wish I could tell you I had it all figured out," says Nancy Whiteman, CEO and co-founder of Boulder-based Wana, "but it wasn't that pretty."

Wana waited about nine months to join the recreational market in 2014. "We had a little ramp-up time," says Whiteman. "When we did enter, we were ready as one could be."

Hindsight is 20/20, but she has few regrets about that decision. "Not being first to market might have been to our benefit," she says. "We had a period of time to see what our demand was and let that play out. We did have a sense from talking to other MIPs that they had a three-to-one [recreational-to-medical] ratio."

It proved correct. Four years later, Wana is the largest cannabis edibles manufacturer in Colorado, and possibly the world. "I think Colorado is still the largest edibles market in the country, until California gets its feet under it," says Whiteman. "We're certainly a contender."

She says Wana ended 2017 with nearly half of the gummi market in Colorado, and about 20 percent of the state's entire edibles market. In a flat market, the company continues to see big growth in 2018. "I think our market share is actually up this year," says Whiteman.

Wana's continued growth is underpinned by a commitment to a long-term strategy. "Even if you're a brand that's been around for a while, you still have to sell yourselves onto the shelves," she says.

The supply chain has changed drastically since 2014. "There was not a lot of trim available, so it's hard to make product for the medical market," says Whiteman. "They tied the plant count to patient count so there was a constraint on the number of plants. What they did with rec, they did away with that. Medical is still limping along with that limit."

The initial lack of raw materials led to a core medical catalog of just four products, but it's night and day as far as recreational plant material goes in 2018. After big grow operations came online in 2014 and 2015, abundance became the norm, and prices have gone down by 35 to 50 percent. "We're able to source plant materials at a much lower price than we were a couple of years ago," says Whiteman. "That's no longer a constraint for us."

"Our category -- which is confectionery products -- is expensive from a production point of view," she says. The problem is the equipment caters to small companies and big companies "with relatively little in between."

For Wana, she adds, "It doesn't make sense to invest in plant-level equipment," rather "middle-tier" equipment. "That's been challenging because there just isn't much out there in the market for what we do."

Says Wana's new COO Dan O'Connor: "We're talking about designing our own depositor. Some of the equipment could be designed in-house."

When regulations started requiring imprinted "THC" symbols on product in October 2016, for example, "That was a big, big deal for all manufacturers," says Whiteman.

The bottleneck? "There are not a lot of precision mold makers," she explains. "We did not think everybody and their brother was going to be looking for molds. It was a scramble." And the solution? "We ended up bringing that in-house."

It follows that Wana bought a CNC machine to make its own molds, followed by other equipment. "It's a small but fully equipped machine shop," says O'Connor.

Packaging and testing ran into similar roadblocks as regulations changed. Everybody suddenly needs the same service providers, and there are only so many hours in a day. "The system got stressed," says Whiteman. "Various stressors would be put on the marketplace that we would plan for now. . . . Build in another three weeks or a month of time. They're going to be stressed with other companies looking for the same thing."

The big lesson: "Learning to think all the way up and down the supply chain is something we learned the hard way," says Whiteman, citing the "necessity of doing comprehensive, 360-degree planning."

"The dispensaries are very sensitive to not having a back-order situation," she adds. "One of our principles is we don't release a product until we can fully support it."

O'Connor joined Wana in 2018 after serving as COO for Oskar Blues Brewery. "The primary difference, first and foremost, is you can't ship across state lines," he says. Oskar Blues was able to focus its resources on breweries in Colorado and North Carolina. "Here it's a little different."

With licensees in Oregon, Nevada, and Arizona, Wana is currently in talks with potential partners in big markets like California and Canada.

"What does it mean to operate at a much larger scale than we are at right now?" wonders Whiteman. Manufacturers in Oregon and Nevada "can use our processes for a while," she says. "A California or a Canada is at a whole different level."

"One of our criteria in choosing a partner is that have very experienced operations people on board," says Whiteman, meaning they've worked in large-scale food manufacturing.

"They're going to have good access to capital," continues Whiteman. "It's got to be $5 million or $6 million." In California and Canada, she adds, "A likely scenario is the partner would be working with a multiple brands."

That manufacturer would need deeper pockets in order to afford the varied machinery. "It's all different equipment," says Whiteman of what's needed to make different categories of edibles and extracts.

In other words, take that $5 million and multiply it by a factor of five, give or take.

The Golden State

While legal recreational marijuana has a four-year head start in Colorado, California is the 800-pound gorilla of cannabis markets. With nearly 40 million residents, it's roughly 45 percent more populous than Colorado, Arizona, Nevada, Washington, Oregon, and Alaska -- combined.

Simple math means the state's cannabis manufacturers need to be thinking about scaling from day one.

Founded by Scott Palmer and Kristi Knoblich Palmer in 2010, Oakland-based Kiva Confections has facilities in Los Angeles and San Diego more than 100 employees today.

"The founders thought about the user experience at every step of the process -- from the quality of the raw materials and ingredients sourced, to the warnings and instructions included on the packaging," says Sean Campbell, Kiva's senior director of operations. "With Kiva's commitment to lab testing and certified manufacturing processes, users can trust that they are getting consistent amounts of clean cannabinoids in every product we make."

Photo courtesy Kiva Confections.

Kiva is now in four states: California, Arizona, Nevada, and Illinois. "Each market has their own regulations -- which means their own testing procedures, packaging requirements, distribution protocol, and other unique challenges," notes Campbell. "We have partnerships with other businesses in each of these states, and it takes months of aligning with them before our brand launches. It is a significant undertaking, but one that is absolutely required with the federal illegality of cannabis prohibiting interstate sales and distribution."

As it's grown, the company has scaled with "a mixture of added variable cost and targeted capital upgrades," says Campbell. "Added variable cost comes in the form of labor to cover new product launches and surges in demand. We like to test the market before making a capital investment. Investment in equipment is tricky one, it's easy to see an expensive piece of equipment as the solution to all of your problems, but if the demand isn't there, it's wasted capital, and capital is very precious."

Issues with Kiva's supply chain range from seasonality of chocolate to the need for new machinery in a nascent market. "There are definitely challenges in our supply chain, but we overcome this with a proactive approach of engaging with our vendors to create partnerships that give a degree of certainty around supply and quality," says Campbell. "This is easier said than done, but we have a great in-house team that negotiates our agreements and are fortunate to have the luxury of folks wanting to work with us."

He continues, "On the equipment side, we use a mixture of off-the-shelf solutions and equipment we've created ourselves. In the early days of the industry we often had a tough time sourcing cannabis-specific equipment that could meet the demand, and so we created solutions ourselves. At this point, folks are offering equipment solutions and/or selling processing capacity, but this of course is not always cost-effective.

"If the industry follows the course of others, I'd imagine that eventually there will multiple options at each point in the supply chain to outsource, and multiple equipment vendors, but at this point we are still largely in the early stages and it's a bit hit and miss. Having the capacity to engineer in-house is definitely a great asset."

Oakland's progressive policies have drawn other cannabis manufacturers looking to scale. The maker of California's first vape pen, Jetty Extracts, moved from San Diego in 2016 for that very reason.

"Today, we've got a full production facility and headquarters in Oakland," says Marketing Director Courtney Capellan. "We had to move up to Oakland because of the type of manufacturing and the volume we were doing."

The 60-employee manufacturer now distributes its products to about 250 dispensaries in California. That's down from a high of 600 in 2017. "The reason [for the decline] is the cost of compliance," says Katie McWilliams, Jetty's compliance director. "Not every dispensary has the resources to be fully compliant. There's a little bit of a bottleneck."

Photo courtesy Jetty Extracts.

As of January 1, 2018, new regulations that came online with legal recreational cannabis have stymied a number of companies in California. Jetty planned ahead. "The company has continued to grow, despite these problems," says McWilliams. "Jetty was well-poised to participate in this new market."

For more than a year, the company's leaders prepared for the coming changes. "We were one of the few companies that were ready to go," says McWilliams.

How? Time and money, says Capellan. "It was just foresight," she elaborates. "We weren't lucky, but we were good."

The biggest current bottlenecks are producing enough extracts to meet demand. Jetty steam-distills terpene from its oil, says McWilliams. "We continue to scale up oil production, but you only get so much terpene out of the oil you produce," she explains.

In order to handle these hurdles -- and unknown roadblocks of the future -- Jetty's leaders have agreed to an acquisition by a Canadian company, Cannex, that should close in summer 2018.

Notes McWilliams: "You almost have to take on bigger partners in order to stay competitive."

That's The Werc Shop's business model in a nutshell.

Founded by Dr. Jeffrey Raber in 2010, the Monrovia-based testing lab went into contract manufacturing in 2014 and seen its staff mushroom from five employees to 150 at four locations, including manufacturing facilities in California, Washington, and Oregon.

Raber says the plan allows clients to scale without getting licensed in every state. "We want to support all of them [customers] and move their brand into other states," he says. "We've got a good platform built for them [clients]. We're kind of a flexible middleware kind of player."

And by contract manufacturing for a wide variety of brands, The Werc Shop has developed better equipment for a number of tasks and best practices for cannabis categories ranging from extracts to drinks to tinctures. "We're way ahead on the learning curve," says Raber.

Photo courtesy The Werc Shop.

A moving target

"The conversation we keep having: 'Here's what we're doing, but we have no idea if it's going to work,'" laughs Bob Eschino. "Every one of us is having issues. Every state is different. It's just a moving target at all times."

Eschino is founder and president of Medically Correct, the company behind incredibles, a leading cannabis edibles brand in Colorado. Now 100 employees strong, the company is now in Nevada, Oregon, and Illinois via partnerships and licensing deals. Eschino is looking at a re-entry into California after the company retreated in late 2017, and pursuing deals in Michigan, Ohio, Massachusetts, Arizona, Puerto Rico, and Canada.

Colorado accounts for about 75 percent of sales, but that could soon change: Eschino expects sales to double in the next 18 to 24 months.

In 2014, he adds, "We had nothing but issues. We had a license to produce cannabis edibles, but there was no trim." He says he negotiated deals with dispensaries to guarantee the supply. "Customers wanted edibles, but I didn't have an adult-use grow, and there were none online at the time. . . . There was a time when we had six-week lead times for products. Things were that desperate."

The dynamic is the opposite in 2018. "Now there's so much cannabis on the rec side, prices are dropping quickly."

The price of a wholesale pound of indoor recreational cannabis in Colorado has dropped like a rock, from about $2,000 in 2014 to less than $1,000 in mid-2018.

In 2014, all cannabis went directly to production at incredibles, so there was little room to experiment.  With a market awash in supply, Eschino says, "We can expand our product line."

But now there's a new wrinkle. "The costs to manufacture anything from extractions are skyrocketing," says Eschino. Regulations and requirements are "basically squeezing any profits out of it."

Eschino says incredibles has temporarily shut down its extraction operation to retool. "We turned our flower into high-end extracts," he says. "People don't want that. Everybody wants McDonald's hamburgers and we're making filets."

The company similarly shut down gummi production for about a year due to stamping issues and relaunched in spring 2017. In that year, the category grew by about 300 percent.

"Now we're making 65,000 gummies a day and we're doing most of those by hand. We tried to find any automation that would help us. . . . We finally got so frustrated, we went back to doing it by hand."

In summer 2017, incredibles launched a wellness line with tinctures, bath salts, and suppositories. "It's truly for the patient," says Eschino. "That line has taken off. . . . We just never had the bandwidth to make it a reality. You don't want to put a new product out without being able to support it.

"The weird thing about this industry is the most simple things are the biggest problems," says Eschino, citing difficulty finding basic ingredients like sugar and chocolate. "We get fired from ingredient manufacturers all the time. It's 'Do you sell organic blueberries?' 'Yeah, but not to you.'"

There's a similar dynamic with equipment. "No one would sell us equipment to make a pressed tablet," says Eschino. "It took us a year to get."

Eschino's advice to aspiring cannabis manufacturers is simple: "Don't. I tell them don't. Become a cannabis lawyer, a cannabis CPA, a cannabis consultant. Those are the people making money," he says. "I'm still driving a used car. It's funny what the perception is versus what the reality is. You're not sitting around getting high all day. You're going to make 7,000 chocolate bars today and 60,000 gummies today, and tomorrow you're going to do the same thing. It's work."

"We come from food," he adds. "We operate a high-speed food production facility. That's what my partner, Rich, has done for 20 years. Once you have your employees, equipment, and ingredients, it's plug and play."

He says his motivation comes from "the miracle of cannabis," not money. "From a business standpoint, it's one of the most difficult things I've ever done."

Adds Eschino: "This industry is a tornado."

Photos by Jonathan Castner except where otherwise noted.

Eric Peterson is editor of CompanyWeek. Email him at rambleusa@gmail.com.

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