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Report on Business Cannabis Professional Cannabis Professional subscriber event with James Burns: The full transcript

The following is a transcript of a conference call with James Burns, CEO of Alcanna, parent of Nova Cannabis and Liquor Depot., and Cannabis Professional’s Jameson Berkow. Some of the questions have been edited for brevity and clarity.


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Transcript

Cannabis Professional: Hi, everybody and welcome to the Cannabis Pro conference call on the state on retailing in recreational cannabis. I am Jameson Berkow, I am one of the reporters on the Cannabis Professional team here at The Globe and Mail’s Report on Business. We have a special guest for you today.

James Burns is the CEO and Vice-Chair of Alcanna, you may of course know the company more familiarly as the Liquor Stores North America. Of course, they went through that change to reflect their shift into cannabis.

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Thanks, James, for joining us. We really appreciate it.


CP: Cannabis is still a very small part of your business today?

James Burns: It is miniscule. It is relatively insignificant, which we consider a plus. Our perspective on the [cannabis] retail sector is that it is going to be very similar to what happened here in Alberta when liquor changed from government to the private sector. A lot of people got into the business thinking that it was an easy path to riches and there were probably too many people in the business and the marketplace has a way of naturally shaking that out so the strong survive.

In retail, it is about one thing: location. We are all selling the same stuff, be it running shoes, cannabis, liquor, there is very little differentiation in product for most of retail. There is high-end-low-end-middle-end but it is all retail.

CP: When do you expect the market to reach a level of maturity?

JB: It is almost there now in Alberta. There is, last time I looked a couple of days ago, there were 277 licences and 400 more in the queue.

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It is all about location though. Stores that have been in existence, the few that were open when the moratorium came down three or four weeks after legalization and they stopped granting licences because of extremely low supply. Those stores would have great numbers wherever they were because there were so few.

If people wanted legal cannabis, instead of black market, they drove and found the store no matter how bad the real estate was, no matter if there was no parking. But when you have 500 stores that doesn’t matter anymore.

The people with the best locations on the high-traffic streets with parking with access and located in centres where people are shopping anyways – and those are expensive and owned mostly by big landlords and you need to have relationships – but that is where we are. While there might be some speed bumps industry-wide, we are extremely confident that we will come out the other side stronger. We have the infrastructure and the financial size to be able to do that. Get 260-plus stores and we have 10 cannabis stores, 20 by the end of October and 30 by the end of November and that is still not a big number since it is less than 10 percent of our network.

CP: Speaking of big numbers, what about the $400,000-plus-per-week being generated by your sole Ontario location. How much better is that figure versus your expectations? It is your single highest-grossing store right now even compared to your liquor stores?

JB: No question, by quite a long way. That store is doing close to half a million dollars per week.

But to be honest, the reality is we didn’t have expectations. There is nothing to compare it to, the black market doesn’t exactly open its books and tell you how they were doing. You don’t know.

We were pretty confident it was going to be a good location. We designed it quite differently from our stores in Alberta because of the extremely high transactions we would be processing, and that is what happened. It is designed as a high-processing-transactional store and we knew full well that might only last a year or whatever depending on Ontario and the lottery.

There will eventually, for sure, be competition, and the volumes will inevitably go down because there are lots more places to go. If there is one [cannabis store] on every block you walk to the one on your closest block. Yeah you can price a little different and retail a little different.

CP: If you don’t have any expectations, how do you determine what a reasonable investment in the space looks like if you don’t know what type of returns you’re going to get?

JB: You don’t. You just take a risk. In the grand scheme of our company it was a very tiny risk. It is an investment in getting into that marketplace with a good store in a good location early on and establishing the brand for the time when it is open season for licences and it becomes like any other retailer.

I’m not altogether sure of the logic behind governments protecting future retailers from opening a store because there is no supply.

I can go open a shoe store and nobody makes sure there are lots of shoes for me to buy before they let me open. It is not logical to me but whatever, I’m not in the government and they are going to do what they are going to do. For us it was worth the investment for us to do that and as it turns out it will pay off extremely handsomely, but it wasn’t all financial. That one was some positioning for the market as well.

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CP: How many stores were you planning to open in Ontario before they moved to the lottery system?

JB: We had identified 91 sites in the summer [2018] after Mr. Ford was elected Premier and he made the announcement that they were going to pursue private sector retail. Then the legislation came out and it was capped at 75 per retailer. Then we were going to build 75 because that was where the cap was, but we had identified 91 trade areas and we had locations in negotiation that we wanted to open in Ontario as an initial foray. Then the lottery came and that sort of sealed that.

CP: Had you signed any leases or purchased any property in Ontario?

JB: No, in Alberta we had done that. We are on a lot of leases that we have been carrying for a year now. And they are great sites so we are pleased to carry them. Obviously we would rather they be open but in Ontario, no, we learned our lesson in Alberta to be honest. We did not sign any hard leases in Ontario though and we would have been very reluctant to do that, having been once burned and twice shy, so we got caught on that in Alberta and it made us very careful in Ontario so we had no lease exposure there.

CP: What advice would you give to someone who had won the second Ontario lottery: go it alone or partner with a larger player like Alcanna?

JB: I have had many [winners] call me in the past week and I will tell you what I tell them: you just need to go into it with eyes wide open.

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There is no guarantee there is not going to be more licences coming in two months or four months and there definitely will be a whole bunch. Ontario’s law still says an unlimited number of licences with any one person capped at 75, but otherwise there will be as many as people want to apply so it will be competitive.

Retail is a very difficult business. Retail is detail.

You have to deal with pennies and margins and managing labour and rent can be extremely high and there is nothing you can do about that. And retail is a very competitive business so you can’t just price indiscriminately and consumers are very price conscious, always.

I would just be really careful if some of the players that are out there trying to secure sites, just as we did in the winter at 499 Queen Street West (Nova Toronto) and you have a very attractive proposition from people who know what they are doing and they can teach you how to retail and provide the financial backstop and so on until you get going, you can probably make more sense to do that, frankly.

It depends what people are offering. There are lots of deals floating around out there. For us, it has to make business sense. That one on Queen Street was a bit of an anomaly but anything else, if it doesn’t make business sense for us, we are running a real business

We are not going to pay millions of dollars for an exclusive, which is not that exclusive anymore, for something that could be gone in a few months.

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Then it really is real life, you’ll look at your lease, your location and it is just retail again. We are unlikely to participate this time around, but having said that you never say never. We weren’t particularly aggressive the last time either but the lottery winner we partnered with just happened to be someone – Mrs. Heather Conlon – where she and her husband own a company that happens to be one of our major suppliers to our liquor business. They are based in Ontario but they make locks and safes for our whole chain. They actually approached us and said they know us and how we do business and they wanted to work with us, I would imagine they turned down better offers.

CP: What do you make of that strategy that so many other retailers have been pursuing of essentially dropping big bags with dollar signs on them in front of lottery winners?

JB: Not really my place to comment on what other people do at other companies, but a lot of those entities as I read about them, their only business is trying to start and get a cannabis retail network going. A lot of them have some capital issues as the capital markets have dried up quite a bit for Canadian cannabis, retail at least, so you need to make some noise in the market. It certainly makes sense to me if I was them, but we are not in that position.

CP: You’re the only example of a cannabis retailer that is also an alcohol retailer, what kind of differences have you noticed between the two businesses thus far? We can start in terms of the differences between a typical consumer who walks into one of your liquor stores versus one of your cannabis stores?

JB: It is quite interesting. Liquor is something that has 80-some-per-cent of the adult population drinks at some point in the year whereas with cannabis it is, the numbers are a bit harder to pin down but it is somewhere in the 20s, so you have a much broader base of people in liquor. Liquor people essentially know what they want, they are brand loyal. It is an established industry with some players that are world-class at branding and creating household names. People know what they want.

[Alcohol] is such a mature business, and the customers are mature. They know what they want, and yes, customer service helps, but it’s really not about that. Cannabis is completely different.

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You’ve got a big, bulkier customers. And especially early on, this is changing now, were absolutely people who were frequent consumers of cannabis before legalization. They switched from the black market to the legal market. They were sophisticated, they knew what wanted – essentially, it was high THC flower.

[We] had one of your colleagues come out and watch our store on a Thursday when the cannabis was delivered, and the small period after, with huge lineups, and we were sold out by the end of the afternoon, and there was nothing on shelves for another week.

Those customers knew what they wanted and they came and got it. Whereas, another big subset of customers, and growing, which are people who are new consumers. people who have never consumed it, or haven’t for so long, it might as well be new, are interested in CBD, interested in some of the wellness aspects – things that are written or said as well as the psychotropic aspects of THC and so on.

New perspective consumers are really interested, so there will be a lot of talking in the store, a lot of engagement.

In our Liquor Depot liquor stores, the bulk of our fleet, the average person spends three minutes in that store. They come in, they know what they want, they buy it, and they get out and go on their ways. Our Wine and Beyonds, which is our huge format store – 20,000 square feet, 14,000 SKUs – it makes a joke of anything LCBO has, by the way, but I’ll leave that aside for now – our Wine and Beyonds average customer spends 37 minutes the store. They come to shop and to talk experience.

And cannabis, it’s like our two businesses, but it’s all in one. The experienced customer comes in, buys, and leaves – and that’s a lot of what Queen Street is like – and that’s the only way you can do 500,000 a week in a relatively small storefront like that.

Whereas, other people come in, and they want to learn about it. Often times, don’t buy.

For the liquor store, our conversion rate is 99%. You don’t walk into a liquor store to wonder if you want to buy something and walk out. You know what you’re going to buy, you buy it, and you leave.

CP: What’s the conversion rate for cannabis?

JB: It depends on the neighbourhood, but it would be in the high eighties, maybe.

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CP: Do you think, eventually, there will come a point when there isn’t much difference between a typical alcohol consumer – in terms of conversion rates, time spent in store – we’ll get to a point of maturity in that market? And, if so, when do you think that will be the case?

JB: Well, it depends on the government. Right now, it’s extremely difficult, if not impossible, for the LPs to brand and to get their brands known and to differentiate. That will certainly accelerate when the new products come online in December (vape pens and edibles, and consumables and topicals).

CP: What differences, in terms of the pure business, have you noticed so far? Is there a difference in the average margins, average basket size, have you noticed differences for that yet?

JB: Yes, for sure. Cannabis,, the market, until May, was dominated by the fact of whether there was any supply or not. You only sold what you happened to get. which was what the government had available. and we made mistakes, like many retailers did, like when the dried flower literally dried up.

All that was really available, for much of the winter (January, February, March, April) was oils and capsules. So we bought it. The customers didn’t want it at the price point we offered, so we chose to drop the price to the point that would get it off our shelves.

All products – dried flower and different concentrations of THC as well as oils and capsules, and CBD which were almost non-existent for three months, is now readily available so it will change. the more stores that come, there will be margin pressure, probably. so then, it gets back to location. if you’re in the right place, where it’s convenient and easy, and a good environment for people to go, you’ll do a little better than in a location where someone has to come and find you.

CP: Do you think margins are going to fall as low as the liquor business? Or do you think you will still enjoy a bit of a higher margin?

JB: I think no, not for a long time. The margins are quite healthy in cannabis. We expect they will stay there. frankly, we expect them to go up significantly because the margins, as we understand it, on the new products – the value-added products, vape pens especially, and edibles, topicals – are a lot higher than dried flower. It’s dried flower, it’s a plant. Whereas, this other stuff is more CPG (consumer packaged goods) retails. margins are generally higher in that.

Overall, we are expecting margins to rise once all products that are available are allowed to be sold. We're really looking forward to that in December, and the first half of 2020 when the industry is able to roll out those products and get them on shelves.

We’re also expecting they may be a little slow getting going as they get their facilities going. All products will not be available in huge quantities on December 17, we know that ... that’s fine, that’s normal. By the back half of the year, it will be. That will be great for us, and other people in the sector.

CP: How much more focus do you intend to place on the value-add products, given how much higher margin they have? Are you going to shift more attention to that, once you can?

JB: Yes, absolutely. A lot of customers are asking about it, they ask when is it coming.

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With the qualification that, at the end of the day, one of the sometimes forgotten but relatively obvious points of a retail business: you can’t tell people what to buy. They’re going to buy what they’re going to buy.

You can market it proper way, make sure the pricing is attractive to them, assist them with customer service, but, at the end of the day, the consumer will tell percentage of advertising dollars we will be put to that versus flower. It will be market driven.

But initially, absolutely.

Us, and any retailer, will try to keep it as much as we can. It’s highly anticipated by consumers, as well as by a lot of people who might want to see what cannabis is like, but don’t want to smoke.

Smoking is not a well-acceptable practise anymore, whereas, vape pens, which are so simple and easy. A lot of people waiting for that stuff.

I think it’ll be a really exciting time for the industry.

CP: On the subject on the news that was out this morning, the acquisition that Tilray announced it was buying that Alberta 420....It was a heck of a high price tag. Do you have any thoughts?

JB: 420? They were good. The way they operated and opened and congratulations to them. And again, a rising tide floats all boats, it just validates that cannabis retail may go through some growing pains. And how could it not? It would be silly to think otherwise. But at the end of the day, it is going to be an extremely big retail business and the [licenced producers] in Alberta, which is the complete opposite as Ontario. In Alberta, vertical integration is permitted and almost encouraged so that if an LP owns a retailer, that LP can do anything it wants in that retailer. So the three-tiered system of separating with huge iron walls, vendors, distillers/LPs and middlemen, agents and retailers, which was put in place after prohibition ended in the 1930s.

Three distinct, deliberately separate so nobody could get too big after prohibition when that was put in place, but in cannabis in Alberta they did not do that. Tweed can open Tweed stores and sell nothing but Tweed products if it wants to, but Labatt cannot open a store here and sell only Labatt products. It is absolutely forbidden but cannabis is very different. In Alberta, where 420 is based, and as I said before LPs have got a challenge with branding because there are so many rules against them and how they can brand and get their products known by the public and especially important when the new products come on board soon. So if you own a retailer full out as Tilray will with 420, that gives them an advantage in terms of how they can brand their own products within their own footprint. In Ontario, however, it is the reverse. Current regulation says one or even a group of LPs has more than 9.9 percent of a retailer than that retailer is not allowed to open, and we don’t open their either. Ms. Conlon owns the [Nova] store, we operate under a licence agreement with our name and provide her some assistance.

CP: Where do the more significant roadblocks stand in the way of a more efficient rollout of a retail network across the country, are they more of a provincial issue or a local issue where you have to wait for each municipality to pass new bylaws or decide whether to opt in or out?

JB: It is all of the above, but by far it is the provincial, province-by-province. Even in British Columbia, you have to go through each municipality and wait for the bylaws because that is what the province said you had to do. They could have said something else, as they did in Ontario where the province basically took the municipalities out of the decision and would not let them zone or have their own rules, the province imposed all the rules. But the municipalities are fine, that is not an issue, it is the provincial rules in terms of a national rollout. I don’t think there is any province that treats this product as a retail product, but if you want to open a store it is really a business person’s decision about whether they want to open a store or not and it should be the business investor’s decision on whether there is adequate supply and margins in the business to make it a business decision.

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Why the government would need to somehow intervene and protect potential retailers from themselves mystifies me, but for the time being that is what was in place in every province except for here in Alberta and we had a moratorium here too for a while but that is now gone. Now it is a normal retail environment here where if you build a store you go through the licencing process, they inspect it, make sure you’re compliant and then you open. There is no more waiting, no triaging, certainly no lottery or picking people. It is as close to normal retail as you can get, certainly to the liquor business. If you have a location and it is a compliant location then they give you a licence, but what you do with that licence and whether you make money or not is kind of your business. That is how it should be.

As soon as governments, if they ever do decide to stop, for some reason policing private-sector investors over what they should do or not then there will be a proper national rollout and there will be an appropriate number of stores. People forget that this is supposed to be about getting rid of the black market. And yet, regulations at every level seem to have been written on behalf of the black market, because they make it very, very difficult to compete against them. It is not logical and most things that are not logical will eventually change. I anticipate this will too.

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