managed operations for the vertically integrated …...as a vertically integrated (cultivate,...

Five Questions to Ask About Managed Operations

for the Vertically Integrated

Cannabis Company

Five Questions: Managed Cannabis Operations Xabis, Inc.

2

Contents:

Executive Summary

Question 1: Which cannabis-production operations are

suitable for outside management?

Question 2: Can cannabis-production operations be

scaled effectively?

Question 3: Are Quality Management Systems (QMS)

relevant in the cannabis industry?

Question 4: Which manufacturing technologies are best

for a given operation?

Question 5: How can operational efficiency in cannabis

product manufacturing be improved?

Conclusions


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Executive Summary:

As a vertically integrated (cultivate, extract,

manufacture, sell) producer of cannabis products, you

are already aware of the industry’s potential for growth

in the coming years. Legal marijuana sales in 2017 are

expected to total $9.7B and 2021 sales are predicted to

reach $24.5B. [1] However, if you are reading this white

paper, you may have questions about the future of

cannabis-manufacturing operations as the industry

grows and matures. While a tremendous amount of

capital is flooding into the cannabis market, it is not

clear that all operational investments are equally sound.

This white paper intends to present key questions that

need be asked by stakeholders about the potential of

managed operations – also known as Business Process

Outsourcing, or BPO – for cannabis companies in the

coming years.

BPO consists of the contracting of operations to a third-

party service provider. [2] In recent years, BPO has been

dominated in the news and in the consumer’s mind by

outsourcing of business processes, e.g., IT and customer

service. However, outsourcing of manufacturing

operations is common [3] and will be the focus of the

present discussion related to cannabis cultivation,

extraction, production, and retail operations. Although

managed operations are common in other industries,

the place of BPO in the marijuana industry – due to its

rapid growth and immaturity – is still being defined.

The central purpose of this white paper is to help define

the essential questions that must be asked by vertically

integrated cannabis companies about the suitability of

managed operations for one or more of their core

business functions.

Big growth.

Big opportunity.

Big questions.


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Question 1: Which cannabis-production operations are

suitable for outside management?

Background:

The cannabis industry in the US is rapidly emerging from the

shadows of its hidden, cottage-industry origins. Question 1

acknowledges this fact and is composed of 2 practical parts:

1) Which practices derived from a previously unregulated,

concealed industry are applicable to the legalized,

regulated industry that is now developing?

2) Can a third-party service provider run things more

effectively than companies can achieve in-house? Put

another way: What’s behind the curtain of a

management company?

We’ll briefly examine the implications of the preceding

questions with respect to each of the 4 operational areas

outlined previously.

• Cultivation: A practice with which humans have

been involved for millennia. Because sales of flower

(“buds”) are a huge component of overall cannabis-

product sales, artisanal/craft cultivators have a

place alongside large-scale operations. (Think of the

Size matters. The following factors have different

implications depending on scale of operations:

o Genetics and breeding

o Sanitation and safety

o Growth media, fertilizers, pesticides

o Energy efficiency, water use

o Regulatory compliance

o Automation and labor

Managed

operations

providers:

What’s

behind the

curtain?


5

• Extraction: People have been extracting

cannabinoids into butter and baking pot brownies

for decades – and there is certainly a place for that.

But if a company is intent on commercial-scale

operations, the old methods may fall short.

Following are several factors related to extraction

that a cannabis company should consider in

formulating its approach to those operations:

o Solvent extraction: CO2 vs BHO vs Freon

vs ethanol (and many more)

o Mechanical extraction

o Extraction equipment

o Purification and isolation equipment

o Analytical instrumentation/QC

o Safety, sanitation, and security

o Automation and remote monitoring

o IT, data management, inventory control


o Facility design (directly impacted by the

preceding choices)

o Technically skilled staff

• Manufacturing: This is the part where the infused

butter is baked into the brownies. And many of the

considerations related to extraction apply here,

too. That said, there are additional considerations

because state regulations usually tightly control

cannabinoid content, packaging, and distribution of

finished products.

o Manufacturing equipment

o Analytical instrumentation/QC

o Safety, sanitation, security equipment

o Automation and remote monitoring

o Data management and inventory control



preceding choices)

o Skilled and unskilled labor


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• Wholesale and retail sales: Once your

manufacturing pipeline is ready, the rest of the

world needs to know about your products and then

buy them. This is the operational area that is the

most like existing businesses, with a few additional

considerations:

o Security and regulatory compliance

o Data management and inventory control


preceding choices)

For the sake of practicality, the four operational areas listed

above are considered somewhat separately. However, as the

industry matures and additional efficiencies (and

corresponding competitive advantages) are sought,

additional factors that link all operations become relevant.

These factors encompass activities that affect the entire

company and include:

• Quality Management Systems

• ISO certification

• GMP/GLP compliance

• ERP/MRP

The lists above are not exhaustive but do cover the major

operational requirements. As suggested previously, some of

the historical cottage-industry techniques can be effectively

utilized within the new regulatory regimes while others are

simply irrelevant. As an example, breeding a strain for

desirable aroma can be achieved without any special

technology. On the other hand, developing a strain having a

very specific CBD:THC ratio requires analytical

instrumentation, technical staff, and a rigorous QA program.

Given the immaturity of the industry – particularly with

respect to large-scale processes and regulations – the

interested reader is encouraged to consider how effectively

their company can meet these new (and evolving)

challenges.

Can you meet

the new

challenges on

your own?


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Question #2: Can cannabis-production operations be

scaled up effectively?

Background:

As we suggested earlier, the challenges involved in baking a

sheet of brownies is different from those encountered while

baking 1000 sheets of brownies. The basic problem with

multiplying existing equipment, labor, and processes is that

all the small-scale inefficiencies and waste are also

multiplied. You gain no operational efficiency. Additionally,

new problems arise. For example, how do you

simultaneously withdraw and cool 1000 sheets of brownies

so that none of them burns?

While “getting big” is the goal of many businesses, including

cannabis companies, additional resources cannot be easily

brought online to accommodate many physical processes.

With hosted data storage, for example, a provider such as

Microsoft, Amazon, or RackSpace will gladly let you double

your storage with the click of button.

With chemical and manufacturing processes, however, no

such option exists. Moreover, increasing production by

simply multiplying existing equipment and processes is very

risky.

The considerations for different operations are not

consistent, either. State regulations (and biology) can limit

the productive size of a cannabis plant, which means that

scaling-up processes basically consist of multiplying the

number of plants under cultivation. The amount of light,

nutrients, and water also scale proportionally. There are, of

course, opportunities to increase automation, improve the

building configuration, and so on. But cannabis plants will

never reach the size of the potato pictured on the train car.

Wholesale and retail sales models, although subject to

additional regulatory scrutiny and constraints on location,

A thousand

toy trains are

no substitute

for a

locomotive.


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are well established; scaling considerations will therefore not

be discussed here.

The operations that are constrained by the ability to

effectively scale up are extraction and manufacturing.

Running multiple smaller extractors can be useful up to a

point, for example. After that, it may be useful to consider

larger extraction systems. But even that is not a given,

because pressure vessel costs increased non-linearly with

capacity and the consistent availability of uniform, high-

quality cannabis feedstocks can be a serious concern when

trying to fill an industrial-scale extractor. (If you don’t fill it,

you may be seriously undermining the efficiency gained by

purchasing a larger extractor.)

The bottom line about increasing production of extraction

and manufacturing operations is this: Scaling up physical

processes is first and foremost an engineering issue. Of

course, costs are a critical factor in making decisions about

scaling up, but business units are poorly suited to providing

the technical requirements and engineering constraints

necessary to make the business decision. The issue requires

input from scientists and engineers.

https://www.chemicalprocessing.com/cartoon-caption/cartoon-caption-1/

“We’re still working out the bugs in our scale-up process.”

https://www.chemicalprocessing.com/cartoon-caption/cartoon-caption-1/


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Question #3: Are Quality Management Systems (QMS)

relevant in the cannabis industry?

Background:

Throughout the cannabis industry, superlatives like “top

quality,” premium product,” and “artisanal hand-crafted” are

thrown about like cheap confetti. But the basic reality is this:

Many of the “experts” in the industry has never been

subjected to tough scrutiny about the purported quality of

their products. It’s easy to make claims about quality but

much more difficult to prove them.

Referring again to the cottage-industry origins of cannabis

operations, it is easy to see how we got here. Prior to

legalization, knowledge was distributed largely by word-of-

mouth, and claims of quality, potency, and value were

essentially impossible to dispute. There was no regulation,

and scientific verification was basically irrelevant. Fast-

forward to today: Despite testing requirements imposed by

states, there is still tremendous wiggle room regarding

claims of quality. For example, many states will tolerate a

measured potency that is within ± 15% of the potency stated

on the package. And only a limited set of residual solvents

and pesticides are included in required testing protocols.

The take-home message: Minimum regulatory requirements

are not even close to the best that a company can achieve.

And aside from what is permissible, competition among

cannabis companies is heating up. As consumers become

more sophisticated, they will become more demanding

about the quality of the products they buy.

A company can ensure the quality of its manufactured

products using different approaches. However, it is safe to

say that systematic implementation of a rigorous Quality

Management System (QMS) is a requirement, not an

option, for cannabis companies seeking to be as competitive

as possible now and ready for FDA approval in the future.

Best-in-

class, huh?

Show us

your data.


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Question #4: Which manufacturing technologies are

best for a given operation?

Background:

This question is closely related to Question 2, above, in that

the intended scale of an operation will dictate the nature of

the equipment and processes necessary to efficiently achieve

the desired production capacity. (It is not that hard to

inefficiently produce cannabis products at large scale if

profitability is not a concern!)

To reiterate a previous point: Design (and scale-up) of

manufacturing processes should be left to engineers. Experts

in related areas such as commercial food production can

provide valuable manufacturing insights, but constraints

imposed by use of a drug – also known as an Active

Pharmaceutical Ingredient (API) – mean that process and

product tolerances must be very tight.

And as was implied previously in this paper, everyone has an

eye on federal regulatory approval of cannabis. What this

looks like precisely is anyone’s guess, but a move toward

tighter regulatory scrutiny and pharmaceutical-type

manufacturing requirements such as GxP-certified

operations is likely. As such, keeping an eye on cost-

effectiveness now with a keen awareness of a system’s

potential for GMP compliance – as applied to both food and

drug manufacture – is probably a smart move if the

differential costs are not too great.

Consider cannabis-extraction technologies as an example.

The two biggest contenders for solvent extraction, butane

and CO2, may have different potential futures. Each

technology has pros and cons. Butane extractors are less

expensive and require less technical know-how than CO2

extractors. They also tend to yield a more terpene-rich

product from a single run. On the other hand, CO2 extractors

don’t require an explosion-proof room (Class 1 Division 1),

are tunable for selective extraction of terpenes and

Will you fully

depreciate

your capital

equipment

before

cannabis

regulations

change?


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cannabinoids, and use a solvent that is economically

available in ultra-high-purity grades. (High-purity butane isn’t

cheap and is still highly flammable.)

The preceding characteristics of extraction systems should

also be considered with respect to the implications of each

for future operations in a different regulatory regime and/or

competitive landscape. Additional manufacturing equipment

relevant to cannabis extraction and product creation is listed

below. As with extraction, careful thought should be given

both to current performance of a given piece of equipment

as well as to its expected suitability under tighter

regulations.

• Bulk food mixers/homogenizers

• Bulk liquid dispensers

• Bulk powder/granule dispensers

• Tablet presses

• Packaging equipment

• Labeling equipment

• Coolers and refrigerators

• Rotary evaporators

• Distillation equipment

• Automatic dishwashers

• Laboratory hoods

• Many other pieces of equipment


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Question #5: How can operational efficiency in

cannabis product manufacturing be improved?

Background:

People. Processes. Products. Profit. These four “Ps” are key

elements (but not the only ones) in the operation of a

successful cannabis business. Previously in this paper, we

discussed the critical considerations related to scaling up

extraction and manufacturing components of a vertically

integrated cannabis company. As we pointed out,

engineering-based modifications to physical, as opposed to

business, processes are essential to improving operational

efficiency.

What wasn’t discussed, however, were the efficiency

improvements related not just to the equipment itself, but

also to the ways in which the equipment is operated and the

types of products being manufactured.

As the reader is already aware, people (employees) can

represent a huge variable in the context of a manufacturing

process. Additionally, the product and packaging designs and

specifications can lead to an easy-to-manufacture widget or

an intricate, labor-intensive piece of confectionary art.

(Compare a jar of unrefined oil to a piece of infused

confectionary art.)

There are two components embedded in the efficiency

question. (Neither is necessarily more important than the

other.)

Aesthetics or

maximum

value? What

is your

priority for

your product

set?


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One question: What product set does the company intend to

offer consumers? This is analogous to the Apple-vs.-Android

or WalMart-vs.-Whole Foods question: Are your customers

looking for a gourmet chocolate truffle infused with 5 mg of

THC distillate or a 20-mg sour gummy worm?

The other question: Are your procedures fully documented

so they can be reviewed and evaluated to help identify

inefficiencies and subsequently improve your processes?

Accurate, version-controlled, and complete Standard

Operating Procedures (SOPs) need to be in place for every

activity that materially affects the quality of a process or

product.

SOPs, as key components of a comprehensive Quality

System, are critical pieces from both a quality perspective as

well as from an operational efficiency point of view. This is

where the efficiency of People and Processes can be

evaluated and improved once a given product set is chosen.

While throwing more low-cost labor at production can get

more widgets out the door, the risks increase rapidly with

the complexity of production. In other words, folding boxes

does not require the same skillset as adjusting extraction

conditions to get a more favorable cannabinoid profile to

include in a tablet intended to promote sleep.

While automation can be a big part of the answer, computer

control and monitoring of processes and equipment can be a

challenge for the small-to-medium manufacturer in any

industry. And for cannabis, economical automation and

monitoring may be even harder to achieve than it is for the

small-scale baker or parts manufacturer – the industry is

simply not mature and neither is all the equipment.

In any case, having evaluated efficiency from the

perspectives of People, Processes, and Products, a company

can then assess corresponding improvements in Profitability.

Because profit a big part of what everyone is after, isn’t it?

Automation

and remote

monitoring for

the cannabis

manufacturing

company: Is it

even an

option?


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How to find the answers you need

This paper poses a set of tough questions, all of which are

asking whether the reader’s company has the critical pieces

in place to take operations (and profits) to the next level.

Following are suggestions for finding answers.

Suggestion #1: Assess your company’s ability to

undertake complex processing operations

It is not difficult to find cannabis product companies that

bought an extractor, put together a few recipes, and then

struggled to achieve their business objectives when the

manufacturing component of the operation didn’t fire on all

cylinders. (There are many other pitfalls; manufacturing is

but one of them.)

As we suggested early in this white paper, there are several

potential impediments that can make it difficult to increase

the production of an operation while simultaneously

benefitting from economy of scale. (Recall that simply

multiplying the number of physical processes often

multiplies the inefficiencies and may actually increase them.)

Ask yourself the following questions as you consider

implementing larger and/or more complex manufacturing

steps:

• Do you understand, from a technical perspective, how

to fit the different operations together (cultivation,

extraction, manufacturing, sales)?

• Do you have the resources (capital, people,

documentation) to properly scale up your processes?

• Where can you turn for answers to questions that are

specific to cannabis extraction and manufacturing?

If you cannot readily answer these questions, it may be

difficult for your company to take advantage of the


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opportunities that this emerging industry can offer. Or you

may spend more and take longer to reach your goals than

necessary. The bottom line is that if you have a grand vision

for your vertically integrated cannabis business but don’t

have the technical expertise to get there, you might consider

Managed Operations as an option.

Suggestion #2: Conduct additional in-house

research. (Hint: It doesn’t have to be in the lab.)

As a vertically integrated cannabis company, you may have

in-house R&D resources or you might work with outside

vendors or contractors. If you have the means to investigate

the potential of new products or scaled-up processes, have

relevant staff put together a brief research proposal. If the

work can be completed economically and on a reasonable

time, it can provide valuable insights into the viability of the

project for commercial adoption.

But always remember: Scaling up from a test tube (or a

formerly illegal operation) to a high-volume production line

without proper engineering is a recipe for losing money. If a

new product or process looks promising on the lab bench,

make sure you know how to benefit from economies of

scale.

The shortcut to discovery is to piggyback on the work of

others. But there is a problem when it comes to this

industry: Whereas academic researchers and commercial

vendors publish papers and technical documents,

information about cannabis extraction and manufacturing

can be harder to obtain. Competitors are not keen to reveal

trade secrets and equipment vendors – often with little

experience or competition – have a vested interest in

steering you toward their offerings.

One of the most important things to keep in mind when

reviewing available literature, which can include material


16

available on various websites, is that reliable information

will be clear, quantitative, and backed by actual data. (This

can include both financial and/or physical/chemical

measurement data.) Additionally, all the important variables,

including performance baselines, operating conditions, and

assumptions, should be explicitly declared.

When it comes to cannabis equipment vendors, wading

through the marketing and jargon requires a degree of

skepticism and often requires direct engagement with sales

and technical staff. The key takeaway for vendor-specific

documents is this: If the vendor can’t answer your technical

questions, keep looking.

The same thing is true for Managed Operations service

providers: If the claims are vague and the provider cannot

provide real-world performance data (financial and

operational), then you should steer clear.

Conclusions

Recognizing that competition in the cannabis business is

presently something of an arms race due to the number of

players rushing into the space, it is essential that cannabis

companies ask questions that will help set them apart

competitively. More so than in almost any other industry,

wild claims abound and are hard to evaluate due to the lack

of historical reference information. It is incumbent on the

business owner to ask hard questions and do what it takes to

answer them.

In this white paper, we have tried to identify critical

questions and challenges facing the vertically integrated

cannabis venture as the industry matures and competitive

pressures increase.

The underlying premise – that managed operations might be

an option – is dependent on the technical abilities and

industry-specific knowledge of your company’s employees,

the desired timeframe for implementation, and the

The industry is

in the midst of

an arms race.

(Even if you

didn’t know it.)


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availability of capital to fund an in-house scale-up project. If

these pieces are in place, your company is likely well-

positioned to be an industry leader. If not, there are options

for utilizing others’ expertise – and potentially their

equipment – on a contractual basis. After working through

the questions posed above, you will hopefully have a much

clearer idea of what makes sense for your company.

About Xabis

We published this white paper to help vertically integrated

cannabis companies evaluate the suitability of managed

operations for their businesses.

Specifically, we are promoting the view that a company’s in-

house technical capabilities vis-à-vis advanced cannabis

extraction and manufacturing operations should be a

primary determinant of whether they consider Business

Process Outsourcing as part of their overall business plan.

To find out more about posing the right questions for your

cannabis company – and carefully formulating answers that

acknowledge the risks and benefits of incorporating

managed operations – please contact us at 303.217.2097 or

[email protected].

Xabis Inc

12015 E 46th Ave

Suite 550

Denver, CO 80239

www.xabisinc.com

References:

[1] http://www.businessinsider.com/legal-weed-market-to-hit-10-billion-in-

sales-report-says-2017-12

[2] https://en.wikipedia.org/wiki/Business_process_outsourcing

[3] https://www.forbes.com/sites/greatspeculations/2015/06/22/getting-a-

piece-of-business-process-outsourcing/#12f28af82a64

http://www.businessinsider.com/legal-weed-market-to-hit-10-billion-in-sales-report-says-2017-12

http://www.businessinsider.com/legal-weed-market-to-hit-10-billion-in-sales-report-says-2017-12

https://en.wikipedia.org/wiki/Business_process_outsourcing

https://www.forbes.com/sites/greatspeculations/2015/06/22/getting-a-piece-of-business-process-outsourcing/#12f28af82a64

https://www.forbes.com/sites/greatspeculations/2015/06/22/getting-a-piece-of-business-process-outsourcing/#12f28af82a64

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