The Pipe Dream of Big Marijuana Revenues

On Friday, President Obama offered a “cautionary note” about the legalization of marijuana. “If we start having a situation where big corporations with a lot of resources and distribution and marketing arms are suddenly going out there peddling marijuana,” he warned, “then the levels of abuse that may take place are going to be higher.”

Obama is not alone in suspecting that it is only a matter of time before Big Tobacco moves in. Certainly there has been much excitement expressed in various quarters about the profit-making potential of this budding industry. And while the activity to date has all been of an entrepreneurial nature, the expectation is that the increasing legalization of marijuana to include not only medical but recreational use will make for very attractive business opportunities. Indeed, federal and state governments are counting on that, anticipating that it will be a healthy source of tax revenue.

But there is a catch that many people have not thought about. The marijuana plant is sturdy and not difficult to grow—indeed, in areas where hemp was produced for use during World War II, volunteer hemp plants sometimes still appear growing wild in fields. A Canadian-published magazine distributed throughout North America provides articles on how to grow the plant, and the Internet is awash with articles containing specific cultural techniques.

So imagine a near future when marijuana seeds and even starter plants could be sold through garden centers and other similar outlets much like tomato seeds and plants are sold today. These seeds and plants could be grown in a backyard garden (or even a flower pot on a patio) with the same degree of difficulty as growing fresh tomatoes.

Let’s explore why that might make marijuana an unattractive business proposition for a Philip Morris USA, RJR Reynolds, or Lorillard. To be sure, there are also no laws restricting individuals interested in growing tobacco in a home garden for roll-your-own cigarette-making. But few people grow tobacco plants to make their own cigarettes. Why not? Because it is very hard to duplicate the product quality that a large-scale manufacturer can achieve. Cigarette and other tobacco brands keep their loyal customers, despite very high federal and state taxes on their products, thanks to specific strategies to make those products more appealing to use. Typically a given cigarette brand blends leaves from many different types of tobacco, and also adds special flavorings. Manufacturers guard these recipes closely. Any home gardener seeking to produce cigarettes like the branded ones they have enjoyed would have a very hard time duplicating this blending and flavoring. It might well be impossible. At least, it would be so difficult as to justify simply buying the manufactured product, even at a premium price, and even with high federal and state taxes added.

Think, too, about another sin-taxed good that is possible to make at home: beer. Yes, federal law restricts the quantity produced at home. However, the reason that most beer lovers do not brew their own is that they don’t like the taste of what they are able to make. Getting beer right is beyond the capabilities of the vast majority of people. All but a tiny number of beer drinkers consider it a better option to pay the price and the tax associated with highly regulated commercial brands.

So is marijuana more like growing fresh garden tomatoes, or more like growing tobacco for roll-your-own cigarettes or perhaps making beer at home? Given that only leaves from a single plant are needed to produce quality marijuana, and given that the plants are readily grown, they are closer to tomatoes than tobacco. Think about the many varieties of tomatoes available as seed or as starter plants to home gardeners. Imagine a world in which marijuana plant breeders are equally adept at improving the marijuana genetics for producing a high-quality, easy-to-grow plant. There is a reason there is no highly consolidated industry known as Big Tomato.

Even now, federal and state governments are looking to impose taxes or other restrictions on otherwise soon-to-be legal marijuana production as a way to regulate production and raise revenues. Some have hit upon the notion that they could tax seeds and plants sold at garden stores. The problem for governments is that the purchaser of even only a few taxed starter plants obtained from a commercial garden store could retain the seed from some of these plants, and soon grow plants from the continuing (untaxed) supply of home-grown seeds.

To the extent that businesses set high-margin prices and governments impose taxes similar to those on most tobacco and alcohol products, this will only drive much greater marijuana production in home gardens and patio plots.

The startup companies rushing into business, planning to make their fortune by selling commercial marijuana products, are responding to a real signal: the avid interest of a large base of consumers. And for growers who were in the business to start with, illicitly, the changing laws might seem like a dream come true. They are already quite adept at the horticultural procedures for growing the plant, and legalization removes their biggest source of costs: having to hide what they were doing from the federal government. But the companies who sell cigarettes, beer, wine, whiskey, and bourbon know there is another factor required to turn consumption demand into a profitable business. Their products are moneymakers because they require specialized resources and skills to produce – resources and skills that very few individuals have at home.

If a high-quality marijuana joint can be made by anyone with the initiative to merely collect and dry the leaves of a single home-grown plant, what is the specialized knowledge that makes marijuana production a profitable commercial enterprise?

So we should probably give up on the hope that legal marijuana will be a significant source of tax revenue for federal or state governments. Nor will it represent a blockbuster business opportunity for producing firms. Could we envision a world in which joint manufacturers compete in a highly discerning market – where large numbers of customers are happy to pay a dramatically higher price for, say, a blend of leaves from various marijuana plants with different characteristics and some specialized flavorings? It could be possible, and if so, the major cigarette manufacturers, not small start-up companies, would be the ones most able to do it. But I’ll believe it when I see it.

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