Although maturity varies across countries, the cannabis industry is relatively new globally, and it’s expected to grow exponentially over the next few years. This creates significant opportunities. As the industry evolves, we’re going to see a need for innovative testing technologies that meet changing market expectations. Investing in the cannabis testing lab market can provide novel ways for companies to develop and commercialize innovative testing methods and technologies.
Which geographies present the greatest opportunities?
The pharmaceutical, life science, food and environmental analytical testing industries are highly competitive on a global scale. Few large players dominate most markets, making it difficult to find growth opportunities in traditional testing services. That said, the cannabis industry provides an alternative path to growth; one that capitalizes on many of the same capabilities and expertise. What does that look like around the world?
- In the United States, cannabis is regulated at the state level and the requirements vary from one jurisdiction to the next. State-mandated tests to ensure products are compliant for sale also differ. Meanwhile, a lack of federal regulations makes it impossible to ship cannabis across state lines, limiting efficiencies from scale and creating complexity in operations, since testing labs must operate in so many separate locations.
Although these restrictions exist, the US market is still the largest in the world, accounting for the most product sold. That represents a corresponding need for cannabis testing services. In terms of opportunity, that means companies might consider first building cannabis capabilities in other markets with federal regulations and where they can learn and build scale before entering US states where the greatest opportunities lie.
- In Germany, medical cannabis has been legal since 2017, and the country has established a regulatory framework for the cultivation, production, testing and distribution of medical cannabis. The German regulator sets testing requirements for medical cannabis products that are imported or domestically produced.
Germany has also announced plans to legalize adult-use cannabis. Once that happens, Germany will need expertise for testing standards and standard operating procedures. That holds a lot of promise for companies in more mature markets. Given these testing organizations will already have deep knowledge and capabilities, they will be well positioned to expand into Germany and fill that void.
Combined with the potential introduction of new product forms, labs will need to rely on testing standards and lessons learned from more mature markets. In terms of opportunity, that means most players — including producers, distributors and processers — will initially enter the market from the pharmaceutical industry and will be looking for testing labs that share similar fundamentals to what they’re used to. As the largest cannabis market in Europe, Germany is already highly regulated with tight rules for cannabis. This will only continue as adult use becomes legal, creating additional testing needs to support compliance.
- In Australia, medical cannabis has been legal since 2016, and the country has established a regulatory framework for its cultivation, production and distribution. While the Australian Government sets testing requirements for medical cannabis products, the testing market is still in the initial stages of development. In terms of opportunity, that means testing labs in this nascent market haven’t yet matured and there is lots of room to capitalize on growing demand as medical cannabis and other uses begin to grow. Testing labs can bring much-needed standards and leading practices into this still developing market to ride that wave of growth. As Australia allows for new products, more established labs will be better prepared to adapt to these innovations.
- In Canada, recreational cannabis was legalized in October 2018. Rigorous testing requirements were established to regulate the industry and protect consumers. That said, the increasing pace of product innovation, and the growth of small craft producers, will create a need for more frequent product testing. So far, mandatory testing requirements have protected the cannabis testing sector from the kind of severe pricing and margin challenges other cannabis companies have faced.
How can businesses build on mature market testing momentum?
Analytical testing lab potential is already fostering opportunities in Canada, where the cannabis market itself is comparatively more mature. Therein lies the opportunity for international players to either build on Canadian momentum to unleash the full potential of the analytical testing lab market there — or adopt Canadian leading practices to meet testing demand closer to home. What’s more, organizations can invest in or build out Canadian offerings to learn from this more mature market and then apply that knowhow in other countries.
Canada is already home to approximately 150 analytical testing labs authorized for cannabis testing. Testing labs are a mix of generalists, which offer a wide range of testing services to different industries such as pharma, environmental and food. These companies either have operations across the globe (e.g., Eurofins) or more regional operations (e.g., A&L). These companies were early entrants and used their knowledge from adjacent testing sectors to enter cannabis testing and service LPs. In addition, there are more localized operators that are focused exclusively on testing cannabis and have built their business around servicing cannabis companies. These new entrants have created more fragmentation in the industry and have disrupted many of the existing players that did not prioritize cannabis as a core business unit.
Their focus in the category allows them to build a recurring book of customers and tailor their services and value proposition to the sector. They can better compete with generalists that may have deprioritized cannabis services. The opportunity comes where you can focus on cannabis, speak their language, build a trusted brand, and tailor your services to cannabis and continue innovating.
Mandatory testing regulations have played a key role in shielding the cannabis testing sector from the pricing and margin issues that have plagued other cannabis companies. With a sizeable and fragmented market, the Canadian cannabis testing industry is linked to the overall production of cannabis, which presents significant growth prospects. As demand for cannabis products increases domestically and globally due to exports from Canadian LPs, the need for testing services will only rise.
Additionally, the popularity of non-inhalable products will require more extensive testing, driving further demand for testing labs. Regulatory developments such as defined batch sample sizes could also create more opportunities for testing labs, as producers may no longer be able to conduct in-house testing. Jurisdictions where the cannabis market is more mature can serve as a crucial jumping-off point for labs to develop standards, processes and capabilities that can support expansion into other countries.
Not all cannabis testing labs are perceived as being equal. More and more mid-market and small LPs prefer to work with local labs with a strong cannabis focus. These labs are assumed to have a better understanding of LPs’ needs.
That said, preferences do vary. Decision-makers who have moved from the pharmaceutical or life sciences sectors into cannabis often prioritize labs that also work with companies from that space. Leaders with an agricultural background may prefer labs that offer environmental services. Regardless, as observed in Canada and around the world, we tend to see most labs differentiating themselves around six critical factors:
- Turnaround time
- Testing accuracy
- Consistency in THC and total terpene results
- Customer service
- Pricing
- Value-added services
Organizations looking to grow the analytical testing lab side of their business would be wise to focus on those differentiators while building out the business and proactively mitigating the core risks we see in the testing space overall:
- Regulations are still evolving. In mature markets like Canada, evolving government guidelines have resulted in inconsistent potency measurements across different testing labs. The issue has become a pressing concern, exacerbated by the recent rise in THC values across retail products and independent studies.¹ While we don’t know if Health Canada will implement stricter testing standards in the future, analytical testing labs should look to entrench themselves with LPs, staying closer to R&D teams. Those relationships can offer up meaningful insight and fuel new ways of adding value outside of more transactional lab services — whether you’re intending to build a testing presence in Canada or apply that thinking to domestic opportunities.
- Industry is taking shape. With some stakeholders considering the still nascent industry somewhat unstable, it can be difficult for analytical testing labs to rely on a handful of customers to drive a large share of the sales portfolio. Getting ahead of this requires labs in any jurisdiction to diversify the customer base, offer services outside of cannabis testing or maintain a strong pipeline to continuously bring new clients on board.
- Cannabis operators are pushing the boundaries. Analytical testing labs should be mindful that cannabis operators, as customers for testing services, aim to maximize THC results, as a higher THC often correlates to higher commercial value. A select few cannabis operators have faced criticism for lab shopping over the past two years.² Testing labs should pay close attention to their customer base to ensure their values are aligned and they’re able to build long-term partnerships.
