The Business of Buds: Why Marijuana Prices May Head Lower

Marijuana legalization proponents see a day when the marijuana market looks like the alcohol industry. There would be a range of quality and prices among the products offered and there would be taxes assessed -- perhaps even heavy taxes.

Pot is often called the biggest cash crop in America. The Fraser Institute, a conservative Canadian think tank, estimates that U.S. consumers spend as much as $110 billion a year on marijuana and cash-strapped state governments are starting to see marijuana as a potentially lucrative revenue source.

California, for instance, collects sales taxes on cannabis sold at its non-profit marijuana dispensaries.Ramon J. Hirsig, Executive Director of the California State Board of Equalization said in testimony before the state Legislature that the state could reap as much as $1.4 billion in revenue on a "hypothetical" $50 per ounce tax that could be levied if a ballot measure called Proposition 19 allowing legalization passes.

Which Way Will Pot Prices Go?

As marijuana turns into an increasingly legit business, what will happen to the market price of pot? Wholesale prices in California have fallen by 50% since the 1990s to about $2,500 a pound thanks to a surplus in supply. Harborside Health Center of Oakland, Calif., the largest medical marijuana dispensary, has not raised its prices since opening four years ago. One-eighth of an ounce there can cost anywhere from $16 to $60 depending on quality. Nationally, data reported anonymously to the pro-legalization site Dopestats.com shows that one ounce of low-grade pot sells for an average of $73.53 (up from $60 in 2008), $125.71 for mid-grade (versus $150) and high grade-pot selling for $280.58 (versus $337.50). Keith Stroup, the founder of National Organization for the Reform of Marijuana Laws (NORML) says Dopestats figures are too low for the good quality marijuana, which he says fetches between $400 and $600 an ounce and sometimes.

"The issues of price are very complex. No one can accurately predict what's going to happen when the novelty wears off," says Stephen Gutwillig, California director of the Drug Policy Alliance.

The Rand Corporation has given it a try. The research organization argues that even with a $50 per ounce tax, "researchers cannot rule out consumption increases of 50% to 100%, and possibly even larger." That would bring marijuana use in California to levels not seen since the 1970s. Moreover, Rand estimates that the price of high-quality pot would cost as little as $38 on a pre-tax basis, as the black market for pot dries up.

"Right now part of what you are compensating [black market sellers] for is their risk of arrest and risk of incarceration," says Beau Kilmer of Rand. Prices will fall because of common business phenomena such as economies of scale and greater automation that allows growers to produce pot on a much larger scale without the fear of being caught.

Dispensary Economics

California law requires that marijuana dispensaries be organized on a not-for-profit basis which is how Harborside is organized. At Harborside, which serves 58,000 patients, the average customer spends about $60 a visit. In one year, Harborside has pulled in sales of $20 million.

Harborside Health's executive director, Steve D'Angelo, tells DailyFinance that his dispensary charges a flat 40% mark-up to its customers, whom it prefers to call patients, and that its highest price is $60 for one-eighth of an ounce.

Stroup believes that Harborside overcharges customers. His group, NORML, estimates that it costs about $25 to produce one ounce of cannabis. "They are still charging black market prices," he says.

D'Angelo refutes this idea. "I barely stay in the black," he says, adding that Harborside pours most of its profits back into the business, which provides free acupuncture, chiropractic, hypnotherapy, and yoga sessions.