I am Going To Make A Fortune in the New Legalized Marijuana Market.... Uh, Maybe Not

Here are Coyote's first three rules of business strategy:

  1. If people are entering the business for personal, passionate, non-monetary reasons then the business is likely going to suck.  When I say "suck", I mean there may be revenues and customers and even some profits, but that the returns on investment are going to be bad**.  Typically, the supply of products and services and the competitive intensity in an industry will equilibrate over time -- if profits are bad, some competitors exit and the supply glut eases.  But if people really love the industry and do not want to work anywhere else and get emotional benefits from working there, there always tends to be an oversupply problem.  For decades, maybe its whole history, the airline industry was like this.  The restaurant industry is this way as well.  The brew pub industry is really, really like this -- go to any city and check the list of small businesses for sale, and an absurd number will be brew pubs.
  2. If the business is frequently featured in the media as the up and coming place to be and the hot place to work, stay away.  Having the media advertising for new entrants is only going to increase the competitive intensity and exacerbate the oversupply problem that every fast-growing industry inevitably faces as it matures.
  3. Beware the lottery effect -- One or two people who made fortunes in the business mask the thousands who lost money (Freakonics had an article on the drug trade positing that it works just this way -- while many of us assume the illegal drug trade makes everyone in it rich, in fact only a few really do so and the vast majority are and always will be grinders making little money for high risk).  Even those people who made tons of money in hot businesses sometimes just had good timing to get out at the right time before the reckoning came.  Mark Cuban is famous as an internet billionaire, but in fact Broadcast.com, which he sold for over $5 billion to Yahoo, only had revenues in its last independent quarter of about $14 million and was losing money (that's barely four times larger than my small company).

When I was at Harvard Business School, the first two cases in the first week of strategy class were a really cool high-tech semiconductor fab and a company that makes brass water meters that are sold to utilities.  After we had read the cases but before we discussed them, the professor asked us which company we would like to work for.  Everyone wanted the tech firm.  But as we worked through the cases, it became clear that the semiconductor firm had an almost impossible profitability problem, while Rockwell water meters minted money.  I never forgot that lesson - seemingly boring industries could be quite attractive, and this lesson was later hammered home for me as I later was VP of corporate strategy for Emerson Electric, a company that was built around making money from boring but profitable industrial products businesses.

Of course there are exceptions, but almost every one of these have built some sort of competitive advantage that allowed them to rise above the rivalry.  Google and Facebook are sexy and make money, but they have built scale and network effect advantages that make them hard now to challenge.   Apple makes money now because it has created switching costs (try switching from an iPhone to an Android and ever being able to text again with iPhone users) and a powerful brand.  The NFL owners have enormously sexy businesses but have created a brand and other competitive restrictions that protect their positions (not to mention have perfected the art of sucking money out of taxpayers for stadiums).  But even looking at these examples, the world is littered with folks who tried to be in the same business and failed.  Remember Nokia, Blackberry, Motorola, Lycos, Yahoo, AOL, Netscape, USFL, XFL, Myspace, etc.  I don't really know how strategy is being taught today, but I was schooled at HBS in Michael Porter's five forces.  I still find this framework useful, and probably about as much as any layman needs to know about business strategy.

But what about marijuana?  There are a lot of people very passionate about marijuana.  It is easy to grow (I remember an ex-girlfriend way back in the eighties whose mom grew it in the attic) and easy to sell (there is plenty of retail space nowadays going begging, or there is always the internet).  Every time there is some expansion opportunity in the business (e.g. a new state legalizing) the fact is advertised all over the media.  Overall, most folks are going to fail and most investment is not going to have very good returns for all the reasons listed above.   For most entrants, marijuana is gong to suck as a business for years to come.   And, some states seem to be developing onerous licensing regimes, and this may allow a few folks with the coveted licenses to make pretty good money.  Some day there could well be someone who consolidates the business and builds a powerful consumer brand and drives down costs and increases scale that makes money in marijuana.  But that is years away and typically the person who leads this is not among the initial entrants.  Remember, the vast vast majority of folks who traveled to California in the 1849 gold rush never made a cent.

You can already see this in California (my emphasis added). 

California's marijuana growers are producing far more pot than is consumed in-state — and will be forced to reduce crops under new regulations that ban exports, the Los Angeles Times reported.

"We are producing too much," Allen told the Sacramento Press Club during a panel discussion, the Times reported; he added that state-licensed growers "are going to have to scale back. We are on a painful downsizing curve."

Estimates vary for just how much surplus California produces — anywhere from five times to 12 times what is consumed in-state, the Times reported.


** You can tell I have classical training in business strategy because my goal is return on investment.  One can argue, perhaps snarkily but also somewhat accurately, that there is a new school of thought that does not care about profitability, revenues, or return on investment but on getting larger and larger valuations from private investors based on either user counts or just general buzz.  I am entirely unschooled in this modern form of strategy.  However, the general strategy of getting someone to overpay for something from you is as old as time.  I mentioned Mark Cuban but there are many other examples.  Donald Trump seems to have made a lot of money from a related strategy of fleecing his debt holders.


  1. smilerz:

    Can a state even ban exports?

  2. ErikTheRed:

    "If people are entering the business for personal, passionate, non-monetary reasons then the business is likely going to suck."

    This is statistically absolutely true. The problem is that if you're only entering a business for monetary reasons and don't have personal passion then the business is also likely going to suck. I like to combine personal passion, unusual barriers to entry, overlooked opportunities in industries that are considered unsexy at the moment, and / or combined with unusually high gross margins (1.5x to 2x the industry average - these will probably evaporate eventually, but they give you much more breathing room to get started). Give me at least three out of four and I'll make money. Yes, these opportunities are out there, but you will probably never find them unless you happen to be deeply interested in a sector.

  3. rst1317:

    No! That's interstate commerce. And the Feds already ban exports since mary jane is _illegal_ in the eyes of the Feds.

  4. Mercury:

    The pot business is mostly built around legal arbitrage and the product itself is a commodity for which there is not a particularly elastic demand.

    I'm in favor of decriminalizing pot (already the case in my state) but I'm against full-blown legalization and government regulation because the expense associated with the official infrastructure that the state will build around the pot business will ultimately if not immediately dwarf the tax revenue it takes in for schools, infrastructure and puppies for sick children, making the whole thing a net loss for taxpayers.

    Besides, the more states and municipalities that foster a legalized pot business, the less market share any one locale will have (see top).

    On the other hand, you could have said: "stay away from the bottled water business" circa 1985 and been wrong...

  5. Brad Warbiany:

    As a homebrewer--and one who in the opinion of many people makes excellent beer--I am constantly asked by people trying my beer "so when do you want to open a brewery?" Well, the answer is just about never: I can't stomach the pay cut.

    I love making beer. I love it for personal, passionate, non-monetary reasons. So do a lot of other people. Many of those people have opened breweries. I recently saw that as of 2016, California has over 600 breweries. (https://www.brewersassociation.org/statistics/by-state/) And frankly, I have in many ways a good "pedigree" for success. While I've never been an entrepreneur, I understand that the business plan has to make sense before you start, I am an engineer and can understand process and quality control, and believe that I would be able to work to maximize efficiency in my business.

    But I'm not going to go tens or hundreds of thousands of dollars in debt to go into a saturated market, where my baseline plan would be to open a neighborhood brewery, work backbreaking labor, in order to squeeze out a middle-class lifestyle. People already pay me too much to be an engineer to ever deal with that. Maybe I'd be the next Ballast Point Brewery, who sold for a cool Billion to Constellation Brands. But probably not, because I'd be LATE TO MARKET and unable to sustain the incredible growth to have *led* the saturation of the market rather than *lagged* that saturation.

    Common rule of business, or investing, etc. If *everyone* is talking about a business opportunity or an investment, you're too late. You have to get into it before everyone is talking about it.

  6. bloke in france:

    Business that makes money
    1. High barriers to entry, e.g. O&G, and especially cement, Huge upfront capital costs
    2. Crap businesses, e.g. mending sewers, roads
    3. Anything else unglamorous but needed.

  7. STW:

    Samuel Brannan was the first millionaire from the California gold rush and he made his money supplying hard goods to the miners. I know of one dispensary here in town that has a consulting side business so they can make money from anyone else who want to set up a dispensary. They make money. The others I've seen are fairly poor affairs. The business selling grow lights, fertilizer, and such looks to be doing fairly well too.

  8. Dave Boz:

    Yahoo paid $5 billion for a website? It's a wonder they didn't go broke quicker.

  9. Heresiarch:

    Your ROI goal reminds me of Lowenstein's account of Buffett encouraging Kay Graham to buy back Washington Post stock.

    "Graham thought this was crazy. If a company returned its capital, how could it grow? Buffett's point was that overall growth didn't matter— merely growth per share. It was like shrinking the number of slices in a pizza. If the shares could be retired cheaply— and Post stock was still quite cheap— there would be more cheese on every slice."

  10. Heresiarch:

    Much the same was true about the store owners in Sacramento that became the Big Four; they made their initial money supplying the 49ers, and only then put it into building a railroad.

  11. Heresiarch:


  12. Heresiarch:

    As the famed investor Bill Miller once said, “If it's in the headlines, it's in the stock price."

  13. Heresiarch:

    States aren't allowed to put undue burdens on interstate commerce. Not quite the same thing.

  14. Don:

    Heh! I remember in '99 and 2000 when "the old rules (on profitability) don't apply."

    Stay old-school, because there's no substitute for money in the bank account.

  15. Jeffrey Deutsch:

    Exactly. Personal passion -- not popular passion.

  16. Jeffrey Deutsch:

    Kind of like why there are so many "starving" artists/musicians/writers, and why many internships are unpaid.

    Not to mention why certain college majors are much more lucrative than others.

  17. herdgadfly:

    When business is based upon desired sales levels and not sales demand, losses and business failure is assured. Ask GM and Chrysler.

  18. Matthew Slyfield:

    How can banning exports of a product from a state not be an undue burden.

  19. mx:

    Regarding Mark Cuban, I've always found it fascinating that we declare someone who gets an average joe to pay $200 for worthless beans a conman, while someone who gets Yahoo to pay $5.7B for a worthless business is declared an internet visionary.

    Which is not to say Cuban didn't do one hell of a sales job or that he alone is responsible for the fact that the hype vastly exceeded the product, but the success didn't come from any model of "business" per se.

  20. Rich R:

    I can't speak for other schools but when I received my MBA about 8 years ago we were taught Porter's 5 forces as well as the ROI driven strategy model. I think the "make it look good and get someone to buy you out" model won't last forever...

  21. Heresiarch:

    That's for Congress to say.

  22. DaveK:

    Not exactly on-topic, but I learned a valuable lesson about trendy vs mundane career choices many years ago, and I suspect it holds true today. As it is today, the most popular choice for undergraduates in the E3 degree path (Electrical and Electronics Engineering) was the Electronics side. Virtually nobody wanted to be involved in the boring and often tedious and dirty job of traditional Electrical Engineering, and specifically the parts about getting large amounts of power onto the grid and then to the points of use, whether domestic or industrial. The starting salaries for the Electronics Engineers were comparable or slightly better than for Electrical Power Engineers, and it was a much more "sexy" career path.

    Fast forward a few years, and I discovered that the Electrical Power Engineers were, as a whole, doing rather better, career-wise than the Electronics geeks. They had far better job security and opportunities for advancement in their organizations. In the company I worked for, and several others I knew of, the shortage of Electrical Power Engineers was such that we were offering Engineers (even those in unrelated fields) the opportunity to go back to school, on the company dime and with a full salary, to learn Electrical Power Engineering. And nearly every person who took them up on the offer ended up doing very well.

  23. BobSykes:

    And then there is the small issue that growing and distribution marijuana is illegal under federal law and regulation. All it takes is an anti-drug administration to shut it all down. And this time the prosecutors have names and addresses.

  24. cc:

    Many millionaires got rich with boring businesses like owning a plumbing business or chain of dry cleaning shops.
    Another example of a "sexy" profession is college teaching. Everyone thinks you have a great time, summers off, high pay. The high pay is only true at some big schools. You don't get summers off because you spend it either writing grant proposals or doing the research. The "great time" probably used to be true but teaching loads have gotten heavier. Many universities now use adjuncts and fresh Ph.D.s may spend years as an adjunct before getting a tenure-track job. I know some of these and the pay and conditions stink.
    Pot has no barriers to entry except what the gov puts up.
    A great book about this process is Peter Drucker's classic "Innovation and Entrepreneurship". I used it as a model to open a software business where I knew I would get outcompeted eventually, so I invested the minimum, took my money and then folded it up when appropriate.

  25. Craig:

    Another important factor is inventory turn. The profit margin on an individual sale of a can of corn at the grocery store is quite small. But if you can buy another can of corn and repeat the sale 20 times a year, the annual return can be pretty fair. Auto dealers try to do business the same way. Get it off the lot and make some margin, and buy another car. Lather, rinse, repeat.

  26. Craig:

    The other difficult issue with marijuana is that it is an all cash business, even legal sales. Federally regulated banks won't touch it, so no checking accounts or credit cards. Security is a nightmare. I don't know how they handle paying employees or suppliers. And suppliers can get stiffed without much recourse in the courts. California is considering a state bank just for marijuana sellers, http://www.latimes.com/business/la-fi-public-bank-marijuana-20170727-htmlstory.html

  27. Craig:

    The electric power industry is facing a demographic crisis. Engineering and IBEW jobs are dominated by baby boomers and they are retiring. Replacing them is a real challenge, just as we badly need to improve the grid. One high-altitude nuke blast could take out electricity in much of the country for weeks if not months. That could be the greatest crisis ever faced in America.

    I fell into a job right after law school doing utility regulatory work with a large Michigan electric/gas company. Nobody goes to law school to be a utility lawyer! Now, almost 35-years later, I am still focused on utility regulatory law, whether for electric, gas, or water utilities or representing their customers. I make a good living working out of a spare bedroom, most days in shorts and sandals. The work is not sexy, maybe even geeky, but I'm good at it and still have fun. The hardest part is when I'm on a conference call in serious attorney-mode and the dog starts barking at the UPS deliveryman.

  28. Dan Wendlick:

    The issue falls into the joint sovereignty under the US Constitution. Even in it's pre-1930s incarnation, this could come up. It is legal under California state law to sell marijuana. It is legal to sell marijuana in Oregon. It is still illegal under Federal law to introduce marijuana into interstate commerce - ship it from one state to another.

  29. Heresiarch:

    Which brings up an interesting question about the applicability of Wickard v. Filburn.

  30. John_Q_Galt:

    Oil and gas.