Navigating the Future of Cannabis Regulation: Lessons from Colorado and Washington

As the U.S. Drug Enforcement Administration (DEA) takes steps to reclassify marijuana as a regulated medicine, a significant shift in the legal landscape is poised to occur. This reclassification, likening marijuana to substances such as Tylenol with codeine or certain steroids, will compel 26 states where cannabis is currently illegal to re-evaluate their stance on the drug. These states must decide whether to maintain their prohibition on cannabis or embrace regulation in line with federal changes. Notably, states like North Carolina already have laws in place that will automatically legalize cannabis once the federal reclassification is enacted.

The experiences of early adopters, particularly Colorado and Washington, offer valuable insights into the complexities of regulating a newly legal cannabis marketplace. Both states have over a decade of experience in regulating recreational marijuana, each adopting distinct approaches with varying outcomes. As more states face the imminent challenge of regulating cannabis, understanding the lessons learned from Colorado and Washington can provide a roadmap for navigating the intricate process of cannabis legalization and regulation.

Early Adopters: Colorado and Washington

In 2012, Colorado and Washington made history as the first two states to legalize marijuana for recreational use. Despite embarking on this journey together, the regulatory strategies they employed diverged significantly. Colorado chose a more competitive model by allowing an unlimited number of marijuana retailers. Economists generally argue that such competitive markets, characterized by a multitude of businesses, benefit consumers by lowering prices and improving the quality of goods and services.

Washington, in contrast, opted for a more controlled approach by limiting the number of retailers and restricting competition. This strategy aimed to maintain higher prices, thereby deterring overconsumption—a concern rooted in the potential societal burdens associated with excessive cannabis use, such as increased healthcare costs and adverse effects on adolescents.

Surprisingly, despite Colorado’s more competitive marketplace, the anticipated significant difference in retail marijuana prices between the two states did not materialize. In 2022, average marijuana prices in Colorado were slightly higher than in Washington. This paradox invites a deeper examination of the factors that contribute to this unexpected outcome.

The Impact of Retail Licensing Caps

The divergence in cannabis pricing between Colorado and Washington can be attributed to three critical policy differences: the cap on the total number of licenses allowed by each state, the size of companies permitted to operate, and the approach to vertical integration in the marijuana industry.

When Colorado first legalized recreational marijuana, the state adopted a liberal approach by offering unlimited cannabis licenses for growers, distributors, and retailers. This approach fostered an environment of intense competition, with many businesses entering the market. In contrast, Washington imposed a cap on retail licenses, initially limiting them to 334, or 4.8 dispensaries per 100,000 people. This cap was later increased to 556 to accommodate medical dispensaries, though as of March 2024, only 469 of those licenses were actively in use.

In comparison, Colorado boasts 680 retail licenses, equating to approximately 14 dispensaries per 100,000 people—nearly three times the per capita number in Washington. While these figures suggest that Colorado’s marijuana industry is more competitive, the reality is more nuanced. The second policy difference, concerning the size of businesses allowed to operate in each state, complicates the picture.

A David vs. Goliath Market: Business Size Regulations

Washington’s regulatory framework favors small businesses by limiting the number of marijuana licenses a single business can own. Each recreational marijuana business in Washington is restricted to owning a maximum of five dispensaries, three grow operations, and three processing facilities. This approach creates a market environment conducive to small-scale operations, with the average Washington marijuana business holding just 1.24 licenses.

Colorado, on the other hand, allows much larger business operations. The average marijuana business in Colorado holds 9.6 licenses, with some large chain companies dominating the market. For example, LivWell, a prominent marijuana chain company, currently holds 24 active recreational marijuana retail licenses across 14 Colorado cities and operates two large cultivation sites in Denver.

The presence of large chain companies like LivWell and Native Roots in Colorado’s marijuana market creates a challenging environment for small independent producers and dispensaries. Despite the availability of seven times more licenses than in Washington, these licenses are concentrated in the hands of far fewer companies, resulting in a less competitive market with higher prices.

The Role of Vertical Integration in Marijuana Markets

The final significant difference between Colorado and Washington’s regulatory approaches lies in their treatment of vertical integration. Vertical integration refers to the ownership and control of multiple stages of production and distribution by a single company. In the marijuana industry, this means that a business can own and operate farms, processing facilities, and retail dispensaries.

Colorado initially embraced vertical integration by requiring all licensed marijuana retailers to be vertically integrated during the first nine months of legalization. This meant that each retailer had to grow at least 70% of the marijuana they sold. The rationale behind this requirement was to prevent black market marijuana from infiltrating the legal market, ensuring that dispensaries sold only what they themselves had cultivated.

However, Colorado abandoned this requirement in 2018, allowing companies to grow and sell marijuana to any retailer. Despite this change, many businesses in Colorado remain vertically integrated, resulting in a market environment where a few large players dominate.

Washington, in contrast, strictly prohibits vertical integration in the marijuana industry, instead applying a three-tier system similar to that used in the alcohol industry. This system requires separate entities to handle production, distribution, and retail, creating a tightly regulated market that limits the influence of any single company.

Vertical integration has a complex impact on marijuana prices. On one hand, it can lead to lower prices by reducing the number of markups along the supply chain. When a vertically integrated business sells directly to consumers, the product is marked up only once, saving money for the consumer. On the other hand, vertical integration can drive prices higher by making it difficult for small, stand-alone companies to compete, leading to a more concentrated market with less competition.

Lessons for Lawmakers: Balancing Competition and Control

The experiences of Colorado and Washington highlight the complex interplay between competition, market concentration, and vertical integration in determining marijuana prices. As more states consider how to regulate cannabis in the wake of federal reclassification, lawmakers face the challenge of balancing these factors to achieve their desired outcomes.

For states aiming to lower marijuana prices and promote consumer access, policies that encourage competition by approving more licenses, restricting business sizes, and allowing vertical integration may be the most effective. By fostering a competitive market with numerous small businesses, states can create an environment where prices are driven down by market forces.

Conversely, states that wish to limit cannabis consumption by maintaining higher prices might consider capping the number of licenses, not restricting business sizes, and prohibiting vertical integration. This approach would create a more controlled market with fewer businesses, potentially deterring overconsumption and minimizing the societal impacts associated with excessive cannabis use.

Ultimately, the path each state chooses will depend on its specific goals and the unique challenges it faces. By learning from the experiences of Colorado and Washington, states can better navigate the complexities of cannabis regulation and create policies that reflect their values and priorities.

Conclusion: A New Era of Cannabis Regulation

As the reclassification of marijuana at the federal level looms on the horizon, the regulatory landscape for cannabis in the United States is set to undergo a significant transformation. The experiences of Colorado and Washington, as pioneers in the legalization and regulation of recreational marijuana, offer valuable lessons for the 26 states that may soon need to develop their own cannabis policies.

These states face critical decisions about how to structure their marijuana markets, balancing the goals of promoting competition, controlling consumption, and ensuring public safety. The regulatory choices they make will have far-reaching implications, not only for the prices consumers pay but also for the broader societal impacts of cannabis legalization.

By carefully considering the lessons learned from Colorado and Washington, lawmakers can craft policies that align with their state’s values and priorities, whether that means fostering a competitive market, limiting consumption, or striking a balance between the two. As the nation moves toward a new era of cannabis regulation, the importance of thoughtful, informed policy-making cannot be overstated.

 

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