While visiting Denver last month to research an article about marijuana legalization, I witnessed a puzzling phenomenon: Cannabis entrepreneurs were demanding an onerous rule requiring vertical integration, while politicians and regulators favored a more flexible, less prescriptive approach. The explanation for this role reversal lies in the vested interests created by Colorado's complicated medical marijuana regulations, which helped set the stage for full legalization but left a legacy of anti-competitive restrictions that may continue to warp the emerging recreational market for years to come.
Since 2010 medical marijuana centers (MMCs) in Colorado have been bound by what is known as "the 70/30 rule": They must grow at least 70 percent of what they sell, and they may not sell more than 30 percent of what they grow to other MMCs or producers of cannabis-infused foods. This rule forced uncomfortable mergers between growers and sellers, required expensive investments in cultivation space and equipment, and, along with a regulation limiting MMCs to six plants per patient, demanded burdensome recordkeeping and reporting to account for every last gram. Having gone through all of that, many MMC owners contemplating the recreational market worry that they will face competition from newcomers unencumbered by the 70/30 rule. This week the Amendment 64 Implementation Task Force tossed them a T.-rex-sized bone, approving a recommendation that the state legislature maintain the 70/30 rule for at least three years and bar new businesses from competing with the existing MMCs during a one-year "grace period." The task force is also recommending state limits on the size of marijuana growing operations and on the number of licenses one business can hold.
The task force's recommendation (scroll down to "Recommendation #RF-6") argues that "restricting license applications to existing medical marijuana licensees, and those with pending applications with the state licensing authority, for a specified period of time ensures the transition to and expansion of recreational marijuana will be controlled." It says "limiting the size of cultivation facilities will reduce the risk of excess production that could increase the risk of diversion outside of the regulated model," while "restricting the number of licenses permitted under the vertical integration model by any single common ownership business structure will limit the risks of market domination by a few players." All of which sounds like window dressing for regulations that serve the interests of incumbent businesses at the expense of new entrants and consumers.
Tellingly, the recommendation offers no real justification for keeping the arbitrary 70/30 rule, although it alludes to "the risk of diversion." Until now, "diversion" meant that marijuana intended for patients ended up being sold to recreational users. But now that Amendment 64 has broadened the legal marijuana market to include anyone 21 or older, "diversion" means marijuana going to people younger than that or to people in other states. Either way, there is no reason to think that vertical integration is necessary to prevent diversion. In other industries where diversion is a concern, such as alcohol and pharmaceuticals, retailers are not required to manufacture the products they sell. With alcohol, in fact, the opposite is true: The regulatory system that most states (including Colorado) adopted after Prohibition generally forbids vertical integration.
Amendment 64 declares that "marijuana should be regulated in a manner similar to alcohol," which is hard to reconcile with a requirement that retailers produce 70 percent of what they sell. Jack Finlaw, co-chairman of the Amendment 64 task force, observed at Tuesday's meeting that "if you read Amendment 64 in its entirety, this [recommedation] is going in a pretty dramatically different direction, and I think we need to be prepared to answer questions from the public about embracing a model that is the antithesis of how we regulate alcohol." Supporters of the 70/30 rule draw an analogy to brew pubs or wineries that sell directly to consumers, but in neither of those cases is everyone who sells the product required to make it; you can still buy beer and wine from retailers who had nothing to do with producing it.
At a January 24 meeting of the Regulatory Framework Working Group, the subcommittee that proposed the recommendation approved by the task force on Tuesday, Denver City Councilman Chris Nevitt was baffled by the argument that the 70/30 rule prevents diversion. "I am still left scratching my head about vertical integration and why it is so important," he said. "The 70 percent rule is endlessly complicated and confusing….I totally understand the anxiety of an industry that has made all of these investments and put your asses on the line….But I am still scratching my head." He was not the only one. In a nonbinding straw poll, the vast majority of the working group favored a regulatory system that neither requires nor forbids vertical integration. The only votes in favor of the 70/30 rule came from representatives of the medical marijuana industry. "We need to maintain the edifice of what continues to work in Colorado," insisted Norton Arbelaez of the Medical Marijuana Industry Group. "A decoupled system would require an exponentially larger number of transactions. The risk for diversion is enormous." Meg Sanders, proprietor of Gaia Plant-Based Medicine, allowed that "there are a lot of ways we can tweak the existing system" but warned that "we shouldn't throw the baby out with the bathwater."
During the public comment period, one MMC owner after another got up to echo Arbelaez and Sanders. "The current medical marijuana system works for us," said Erica Freeman of Choice Organics, an MMC near Fort Collins. "Changing the rules again will force new mergers," warned Tad Bowler of Rocky Road Remedies in Steamboat Springs. "The small centers won't be able to compete." Bruce Grainger, co-owner of Kind Love in Denver, offered a counterintuitive defense of current restrictions, saying, "Competition actually works, and the free market works." Chris Bokidis, owner of the Kine Mine in Idaho Springs, argued that Colorado's strict regulations have helped ward off federal interference, because "a closed market is a controlled market." Michael Elliott, executive director of the Medical Marijuana Industry Group, declared "we are united" in supporting the 70/30 rule.
But not everyone in the industry agrees with this line. "The 70/30 rule does not work," declared Jessica LeRoux, owner of Twirling Hippy Confections in Denver. "This is not vertical integration. This is vertical protectionism." LeRoux, who sells cannabis-infused chocolates and cheesecakes to MMCs across the state, said that while some of her customers would continue to grow most of the marijuana they sell after switching to the recreational market, others are in rural areas where they would not be able to find the warehouse space necessary for a bigger grow operation. As she later explained it to me, "I want everyone to have autonomy and choice and the ability to do what they think is best for them and make investments that make sense."
That was not the position that ultimately prevailed, although it initially seemed to have majority support in both the working group and the task force. The recommendation approved this week is a compromise in the sense that it says the 70/30 rule should sunset after three years (lengthened from two years in the original version), "at which time the General Assembly shall consider de-coupling the manufacturing and retail licenses and propose an 'open integration' model."
Rob Corry, a Denver attorney and longtime marijuana reform activist, calls the 70/30 rule "completely unworkable and economically illiterate." But he also sees a postive aspect to the wrangling over vertical integration. "On the one hand," he says, "I'm disappointed at rent-seeking behavior and businesses that seek the heavy hand of government to prevent them from getting any new competition. On the other hand, it means that our industry has grown up and is behaving like every other industry out there."
[I have corrected the quote from Amendment 64.]