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Staring Down the Marijuana Industry Through

Over the past several months things have been rocking in the marijuana industry. Shares of the biggest marijuana company (by market capitalization) Canopy Growth Corp (TSX:WEED) roared to over $17 per share, only to settle around the $10 mark.

While many investors are very excited about this new growth opportunity, not everyone is jumping into the mix. With investors as split as ever, let’s take a look at the industry by applying Porter’s five forces to get a better idea of the potential for long term profit in the industry. Before we launch into it, we have to be clear, we are evaluating marijuana growers and not the retail locations which will eventually sell the product.

Threat of new entrants

The threat of new entrants is characterized by the possibility new competitors will enter the market. In the case of the marijuana industry, the only thing stopping new growers from entering the market is the approval required by the government.

If competitors in the industry ever make high profits, the industry may get crowded. The process of setting up a greenhouse to grow plants is likely not very difficult to replicate.

Threat of substitutes

The threat of substitutes is the possibility another product can replace the benefit received from consuming marijuana.

A good example of this threat is what the alcohol industry is going through now that marijuana is going to be legalized. If consumers can enjoy marijuana, they may consumer less alcohol.

For the marijuana industry, the threat of substitutes is very low at this time, given the product is one of the first illegal drugs to be legalized.

Bargaining power of customers

If there are multiple producers of a product, then the customer has the ability to easily leave one producer and go to another. Taking our mobile phones as an example, consumers have very few choices which results in the tolerance for higher prices and inferior customer service.

The marijuana industry has only a few producers at this time. We can thank Canopy Growth Corp for this.

Bargaining power of suppliers

In the case of the marijuana growers, the suppliers are the hydro company, the company that sells land and the water company. Once the plants have been acquired, there is very little bargaining power on the suppliers side.

This may be the best thing the marijuana producers have going for them!

Industry rivalry

The industry rivalry is a very important force investors need to recognize. As a consumer of pizza, I receive coupons on a weekly basis with the promise to save more than ever before on my next purchase. This can be bad for investors.

Given the regulations of the industry, the industry rivalry is going to be very difficult to figure out in advance.  While there is almost no product differentiation given the new regulations within the industry, it will probably remain highly unlikely that the company’s will be sending out coupons for savings on bulk purchases of marijuana. The “rivalry” will probably be in the form of consumer education or overnight delivery from the producer to the retailer.

With a high growth industry still in development stage, it is very difficult for investors to measure out in advance the likelihood of higher or lower returns on equity. Buyer beware!

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Fool contributor Ryan Goldsman has no position in any stocks mentioned.

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