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  • Writer's pictureErik Ott

Brand Market Expansion: Negotiating IP Licensing Deals – What’s Involved

The cannabis industry has reached peak expansion mode as brands and licensed operators across the states form IP licensing agreements to enter new markets. While there are many different approaches to brand expansion, as we have begun to document in the Deep Roots webcast series, the path to success requires attention to many details. In this 3-part series, we share best practices in three key areas:

  • Internal analysis on where to go

  • Initial Partnership engagement and analysis

  • Agreement negotiations and closing

Part 1: Internal Analysis – Where To Go and What To Look For

Today’s rapidly changing cannabis market presents entrepreneurs with diverse options and strategies for brand expansion. Any initial foray into a new market will requires a significant amount of upfront work to frame the opportunity. Between the recreational and medical markets there are dozens of potential expansion options to consider, each with unique nuances and attributes that can impact success. In part one of this series we explore what a brand needs to consider before engaging partners in brainstorming or exploratory discussions.

What are the key areas of internal analysis? At a minimum there are five areas that need to be tackled when developing a well-conceived brand expansion strategy. These include:

  • Regulatory model

  • Product-market fit

  • Partner ecosystem

  • Capital requirements

  • Supply chain dynamics

Regulatory model: Any cohesive market entry strategy starts with an understanding of the regulatory environment. The easiest things to understand are (a) whether the market is open or limited license and (b) how the regulatory framework was constructed from a philosophical perspective – for example, many states initially required vertical integration while others did not. The structural relationship between retail and the supply chain can help determine whether a state will make a good investment. From there, a clear understanding of any product, dosing, or packaging restrictions will provide brands with a baseline knowledge of what adaptations may be required to enter a new market. There are also regulatory frameworks that are designed to support the entrepreneurs based in the home market and reduce the influx of MSOs or out-of-state brands. Vermont is a good example of a state that has set up barriers to circumscribe MSO access.

In this preliminary phase, brands need to look for “gotchas” that make investment untenable. In short, one should assume that regulations drive the business opportunity: understanding what regulatory intent at market formation will provide guidance as to how friendly that market may be to out-of-state brands.

Product-Market fit: Because expansion into new markets is becoming a critical way to scale brands, the term “product-market fit” is becoming a bit of a buzzword in cannabis. Product-market fit is a cannabis is slightly different than in other industries. Given the fragmented nature of the cannabis industry, innovation is hard to quickly capitalize on at scale. It may be possible for a brand to introduce an innovation in one state, e.g. develop the first infused pre-roll, but by the time it can get to a new market another brand may have already copied that idea. In any case, new market entry needs to be data driven and focused on the competitive landscape. Brands should invest in market analytics to gauge the depth and breadth of any new market opportunity. In most product categories three tiers of price point have been established: good/value, better/middle and best/premium. Therefore, it is critical that brands understand the competitive landscape positioning a brand in a different price tier than in their home market is not congruent with a thoughtful CPG strategyOf course, a full understanding of product-market fit will not be possible without a similarly deep understanding of the supply chain, so fit will be an ongoing exercise once potential partners have been engaged.

Partner ecosystem: Information gleaned from the regulatory framework will help brands develop the options in the partner ecosystem. At a high level, most markets offer three paths: partnering with a pure-play co-manufacturer, partnering with another brand, or some combination of the two. There are pro and cons to each approach depending upon the brand strategy. Typically, a relationship with a pure play co-manufacturer requires the brand to invest more in sales and marketing as this is not a core competency of the co-manufacturer. Some brands prefer to control their own destiny in a new market; in those cases a co-manufacturer partnership may be a more advantageous route. Alternatively, partnering with another brand can accelerate the path to shelf space by leveraging the existing distribution network, and if the partnership is well-constructed it can mitigate some market entry risk. That said, each model has inherent risks as co-manufacturers are focused on bringing on lots of brands and may not always provide quality of service while brand partners will always prioritize their own brands when in a retail environment.

Capital Requirements: Companies typically underestimate the costs associated with new market expansion. Given the current state of capital markets, most companies do not have the wherewithal to invest adequately in market entry. Unfortunately, the costs of expansion are front end loaded as getting out of the chute correctly is critical to achieving a leadership position. Of course, the most significant investment is in sales and marketing, but the Capex associated with developing a differentiated product can at times be prohibitive. Companies requiring specialized equipment are likely to be on the hook for providing that equipment. One strategy that is used to reduce start-up costs is to utilize old equipment that the brand has “grown out of” in their home market. Another creative path has seen brands negotiate creative equipment leasing terms with their vendors that can be passed on to a co-manufacturing partner. In all cases, entering a new market on a shoestring budget significantly limits the upside potential.

Supply chain dynamics: As referenced above, a deeper dive with prospective partners will be necessary to get a granular understanding of where any given market is trending. However, most markets follow a similar trajectory with regard to supply: an early shortage of cannabis drives prices up, then increased investment in cultivation creates oversupply and price compression, and eventually some level of price settling occurs. For the purposes of early market entry supply chain analysis will help a brand garner an understanding of the cultivation footprint and where market capacity lies. For example, New York has a lot of outdoor cultivation with no meaningful indoor footprint while Massachusetts is mostly indoor with a small outdoor footprint. That may suggest better product opportunities for vape brands in NY that are knowledgeable in fresh frozen extraction to create rosin and resin carts, while high-end flower and pre-roll brands may be more likely to thrive in Massachusetts. The supply chain environment may create CPG product uncertainty if it requires a brand to pivot away from its core competencies. In these situations, locking in supply agreements with cultivators may be a way to reduce risk.

In summary, there is an immense amount of data available to entrepreneurs for informed decision-making. Brands just need to dedicate the time and resources to properly vet each opportunity.

In Part 2, we will look at the initial market engagement phase and explain how to evaluate the multitude of options brands have when choosing partners.

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