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The Ontario government has told its cannabis agency to re-examine its business model and look at allowing growers to ship products directly to bricks-and-mortar retailers, potentially as part of a hybrid public-private distribution system.

The provincial government issued a directive to the Ontario Cannabis Retail Corp. (OCRC) in recent weeks asking it to consider new ways of doing business, according to a government source not authorized to speak publicly on the matter. The request comes after the OCRC, which runs the Ontario Cannabis Store (OCS), the wholesale middle-man between licensed producers and retailers, reported a loss of $42-million in its first year of operations.

Informal consultations on a new business model have begun with industry members, according to several people with knowledge of the discussions. However, no decision has been made on what role the OCS will play going forward, according to the government source.

Discussions about changing Ontario’s pot distribution model were first reported by BNN Bloomberg on Friday. The report said that Ontario was considering removing the OCS from the wholesale business entirely.

A second government source, who was also granted anonymity because they were not authorized to speak on the matter, said that it was unlikely that the OCS will abandon its wholesale business outright. There is talk, however, about introducing a hybrid model where the OCS would continue its warehouse operations for online sales while private cannabis producers would be allowed to ship product directly to bricks-and-mortar retailers, the source said.

The OCS is expected to make a recommendation to the government on how to proceed sometime in early November, they said.

OCS spokesman Daffyd Roderick declined to comment directly on the discussions or industry consultations.

“OCS cannabis wholesale and e-commerce distribution operations will continue to serve Ontarians and facilities are in place to allow for the current planned expansion to 75 stores and new product categories,” Mr. Roderick said in an e-mailed statement.

“OCS continuously considers how to improve operations and services in order to effectively serve Ontarians,” he added.

Emily Hogeveen, spokeswoman for Finance Minister Rod Phillips, issued an e-mailed statement saying only that the government’s approach was responsible and that the OCS remains the province’s exclusive wholesaler of cannabis.

“The government is taking a responsible approach to opening cannabis stores across Ontario, allowing private sector businesses to build a safe and convenient retail system to combat the illegal market while protecting children and youth,” her statement reads. “The Ontario Cannabis Store remains the exclusive provincial wholesaler of cannabis in Ontario.”

Any move toward an LP-to-retailer wholesale model could have a dramatic impact on the cannabis industry, according to Bank of Montreal analysts Tamy Chen and Peter Sklar. In a note published on Monday, Ms. Chen and Mr. Sklar suggested that, over time, cannabis products on store shelves would better align with consumer demand.

“We believe a key contributor to the costly roll-out of cannabis legalization for Ontario has been the procurement of a sub-optimal product mix (relative to rec consumer demand) from LPs,” Ms. Chen and Mr. Sklar wrote. “We would also expect LP revenues to become smoother from quarter to quarter. Currently, LP revenues can be volatile due to Ontario’s pattern of making periodic bulk purchases.”

In the short term, however, many LPs could find their margins squeezed if a new distribution model drives down flower prices, specifically “for LPs with products that have lower rec consumer demand vs. supply.”

“Our sense is that many companies could be impacted by this as we have heard anecdotally that many LPs are selling “mid-range” dried flower (10-15 per cent potency and retail pricing of $8-10/g), which may now be an over-supplied category with limited product differentiation,” wrote Ms. Chen and Mr. Sklar.

“While it is difficult for us to assess which LPs’ current products are aligned with rec consumer demand, we believe the LPs with stronger cash positions should be able to better adjust through the transition period and establish an optimal product mix of dried flower and Rec 2.0 formats.”

Underpinning the discussions happening at the provincial level are challenges Ontario has had rolling out its cannabis retail program. Only 24 legal stores are open across the province, and the second lottery to award 42 more licences has been messy.

Eleven lottery winners, who were disqualified from the process for not submitting their letters of credit by the deadline, brought the licensing process to a standstill in mid-September by asking for a judicial review of their disqualification.

The panel of judges ruled against them on Friday, but on Monday the group of disqualified winners said they would appeal the decision. The Ontario Court of Appeal will decide on Tuesday whether to hear the appeal.

- With files from Jeff Gray at Queen’s Park

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