California’s Approach to Medical Marijuana Distribution and Transportation
In 1996, California became the first state in America to decriminalize marijuana and allow patients to obtain marijuana for medical purposes. This industry started as a movement; a movement which began in California and has since swept the nation and the world with a wave of activism and legislative reform. It began as a movement that was strictly not-for-profit and non-commercial. Over the course of the years, we have evolved into an industry more quickly than the laws have evolved to accommodate for commercial cannabis activity.
After nineteen years of attempts to effectively regulate medical marijuana in California, in October 2015 the Medical Marijuana Regulation and Safety Act (MMRSA) was signed into law by Governor Jerry Brown. Brown, formerly the California Attorney General, is no stranger to Medical Marijuana Policy. Brown’s 2008 AG Guidelines have been the presiding framework for legal medical cannabis activity along with the 2013 Cole Memo which provides guidance related to federal enforcement priorities and indicates the requirement for “strong and effective regulatory and enforcement systems to control the cultivation, distribution, sale, and possession of marijuana.”
Years later, California has finally enacted a law to fulfill these federal requirements and ensure the protection of California cannabis patients, growers, and businesses from federal prosecution.
The MMRSA is the result of thousands of hours of deliberation and negotiation between legislators, state regulatory agencies, local governments, law enforcement agencies, labor representatives, and leading industry groups representing patients, cultivators, manufacturers, distributors, dispensaries and delivery services, testing laboratories, and ancillary service providers. The MMRSA bill-package was deliberated for nearly a year through a collaborative and iterative process involving policy makers and those to be affected by the policies.
One of the more highly debated topics during the drafting and since the passage of the MMRSA, has been California’s decision to pursue a higher level of regulatory control as it relates to distribution and transportation of medical marijuana, when compared to other medical and adult use states. This memo explores the policy rationale for this regulatory framework and the implications for the existing cannabis industry in California.
Current State of Distribution and Transportation
The list goes on. In many ways we have been self-regulated, as good actors and professional operators have made conscious decisions to uphold high standards for ensuring the safety and security of the products we produce and the way in which we conduct business (such as responsible packaging, lab testing, proper documentation, and upholding best practices consistent with Prop 215, SB 420, 2008 AG Guidelines, and the Cole Memo.) Self-regulated operators have paved the path for the successful passage of the MMRSA. But the majority of operators need clearly defined rules and to be held accountable to those rules, just like any other legal industry.
MMRSA Policy on Distribution and Transportation
The MMRSA is a three-bill package (AB 266, AB 243, SB 643). AB 266 addresses distribution and some aspects of transportation, while SB 643 addresses transportation in more detail as well as the associated traceability requirements.
At a high level, the roles of distributors and transporters are defined as follows:
A Type 11 Licensed Distributor is licensed to engage in the business of purchasing medical cannabis from a licensed cultivator, and medical cannabis products from a licensed manufacturer, for sale to a licensed dispensary. Distributors ensure that products have been batch-tested and verified as safe before entering the retail dispensary.
A Type 12 Licensed Transporter is licensed to transport medical cannabis and medical cannabis products between licensees. Transporters must submit electronic shipping manifests prior to all transport activity, and updating the traceability system at each point for supply chain integrity.
Restrictions on cross-licensure between tiers is another fundamental component of the MMRSA. In large part, but with some exceptions, the law keeps production (cultivation and manufacturing) separate from retail (dispensary and delivery) by not allowing license holders in the production tier to own licenses in the retail tier, which is consistent with alcohol laws in most states throughout the nation called “tied-house” laws. A tied-house is a vertically integrated retailer that produces its own products. Vertical integration can be great from an individual business operator’s perspective (more shelf and marketing control, lower cost of goods sold, higher profit margins) but has its pitfalls for regulators and consumers (no checks-and-balances to ensure compliance, opening the door to abuses in the system and a lack of transactional oversight and quality assurance oversight).
Consistent with Alcohol and Beverage Control regulations since Prohibition, a similar three-tier structure (producer, distributor-transporter, retailer) has been defined for California cannabis regulations. Each business operator stays in their lane, so to speak. For example, distributor- transporters are not allowed to have an ownership in any production or retail businesses. They are viewed as the compliance checkpoints in the supply chain, and therefore cannot have a conflict of interest via ownership in cultivation, manufacturing, or dispensing. Similarly, testing laboratories may not have an ownership interest in any other license type due to the potential conflict of interest that may arise. Distributor-Transporters are partners in compliance for regulating agencies and for production and retail operators.
Why has California taken such a unique approach?
California is different than most other regulated cannabis states; California has the largest production zone in the nation, a vast existing black market that is not incentivized to participate in a pseudo-legal environment, and a vast existing gray market that has developed without regulations and oversight for the past twenty years. California must be treated differently, and these factors must be acknowledged when crafting the right approach to regulation.
Policy makers are interested in accomplishing the following objectives which comply with Federal enforcement priorities outlined in the Cole Memo and California enforcement priorities, including but not limited to:
Eliminating Contraband (illegal product entering the legal retail market)
Non-Diversion (legal product entering the black market)
Protections for Consumer Safety (quality assurance testing and labeling)
Protections for Public Safety (secure transport of product and cash)
Traceability (IT systems and transportation consolidation)
Funding for Enforcement (fees assessment and centralized tax collection)
One of the most disruptive aspects of the MMRSA for current industry operators is the idea that producers who are used to transporting their own products to dispensaries now must use a distributor-transporter. Many fear this requirement will unnecessarily increase the cost of doing business, as these third parties add-on their mark-ups to product along the way. There is certainly a compelling interest for producers to be able to conduct consumer-direct and dispensary-direct sales. Dispensaries already apply a 100% keystone mark-up from wholesale to retail, and in some cases up to 300-400% mark-up on flower. From the producer’s perspective, another middle man will only further eat in to their already squeezed profit margin.
Fears, Myths, and Considerations
Exploring that issue on margins, mark-ups, and the financial implications of a mandatory distributor-transporter tier, it is important to remember that producers have their own cost of distribution already, which will be off-set by that of a third-party provider. Existing costs aren’t always easy to quantify for a smaller operator who, for example, may not consider their own time and resources expended for distribution to build their brand and create their sustained space on the shelf (on the road; in the store; for sales, fulfillment, customer service, and administrative aspects). The costs add up, and take producers away from what is often their core competency – producing great quality products. A distribution partner can actually be the saving grace for many producers, who want to focus on what they do best. Additionally, the MMRSA does not restrict producers from entering into contracts with retailers at set prices for their products. There is also nothing that prohibits a producer from supplementing the efforts of their distributor-transporter by having brand ambassadors on board to ensure relationships with retailers are strong.
Another fear expressed by industry has been the MMRSA requirement for product to be tested at multiple stages in the supply chain (both from cultivation to manufacturing and from manufacturing to retail). Although most manufacturers will require some level of testing or quality assurance before purchasing raw materials, the intent of the law is mainly to protect the end-consumer as related to the consumer-ready good. There is proposed legislation (AB 1575, Bonta) to repeal the requirement for raw material to be tested when sold to a manufacturer – maintaining that as long as the finished product going to the retailer is verified as safe, that will suffice for consumer health and safety regulations.
Distribution has earned a reputation as a dirty word, something worth fearing. Historically, we never used the word in this industry as it directly translated to “trafficking.” But as we enter this new phase of growth and regulatory control, our industry and its operators will benefit from strong distribution partners who solve the pain points felt by producers (significant time, money, and energy dedicated towards acquiring and fulfilling orders in a state which spans half of the Western United States) and retailers (managing supplier relations and inquiries from hundreds of vendors knocking on their door every week).
In every other industry, brands are built on a strong distribution infrastructure. It is important to develop a brand and brand loyalty from consumers in order to secure retail shelf space as the market becomes more competitive. Distributors are strategic partners with the expertise and economies of scale to build brands regionally and statewide, supporting cottage cultivator CSAs, agricultural cooperatives, and infused product manufacturers small and large, rural and urban. Contrary to other rumors about distribution, there are no limits defined in the law nor is it the intention of the policy makers or regulators to impose a limit on distribution and transportation licenses. This has been independently confirmed by the Medical Marijuana Bureau Chief.
Distribution and transportation are off-set by the existing expenses that producers would otherwise incur themselves. The true cost of operating under the MMRSA is the race to become compliant. There are real costs to operating in compliance (building improvements, local permits, legal and accounting fees, internal systems and controls, prospective taxes). Every licensee will “pay to play” to get their business operations up to par to operate in the regulated industry.