Running a Cannabis brand in California with Somatik (Podcast)

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Episode Transcription

Blaine: Hello, everyone. Welcome to episode three of the Distru podcast. Here today, we have Chris from Somatik. I met him a while ago at Gateway where he incubated his company and since then they've grown tremendously and have grown from there coffee wine infused with cannabis to now including chocolate covered espresso beans. Really excited to have him on as a guest. Feel free to introduce yourself, Chris to the audience.

Chris Schroeder:  Hey, Blaine. Thanks for having me. We're really proud of what we've been able to accomplish with Somatik. We launched in 2017, way back in Prop 215 and have survived into the transition of the regulated market in California. As you mentioned, we started with cold brew that we did in collaboration with Ritual coffee, which is a San Francisco based roaster, and have since added a vegan chocolate covered line of super foods. We actually just won our second and third Emerald cup award last weekend. So we're pretty pumped about the quality of products that we're bringing to the state.

Blaine:  Awesome. I personally love their coffee drinks. Great way to start a Saturday morning.

Chris Schroeder:  Yeah, for sure.

Blaine: We like to get a sense of what's actually going on in the industry. That's our goal is to get down and dirty with what's happening on the floor. I'd love to start as a cannabis brand in California. You probably seen so many shifts over the last three years. I'd love to get a sense of in 2019, what is your view of the state of the industry as a cannabis brand?

Chris Schroeder:  Yeah, well, it's definitely been a pretty wild ride. I guess the backup when we first launched in 2017, we first thought that we were going to launch with a co- packer who would manufacture our product for us. We brought the formulation and all of this sort of source inputs, and it was pretty quickly apparent that we weren't going to be able to find someone that was going to be able to produce the product that the quality level that we wanted. So we started building our own factory, and then in 2018 turn that factory into compliant licensable facility.

If you fast forward now, two years into legalization or just about to end our second year in 2019. It's been interesting with a lot of ups and downs. I'd say one of the biggest challenges is that we still have fewer retailers than we had pre-legalization. The estimates of retailers selling under Prop 215 are somewhere between four and 6000 stores that were selling cannabis in California. At the beginning of 2019, we started the year with roughly 600 licensed dispensaries. In the middle of the year, we had about 850 and we're going to end the year with only 650 licensed retailers because not only is the state not quickly approving new licenses, they're suspending licenses. So they're actually adding to this really direct market contraction that makes it really hard for a new industry and hard to compete against competitors, because we're all going for that same very, very limited shelf space.

Blaine:  Do you think that contraption is going to be felt in the form of like a revenue draw, or even revenue total in California will still go up in 2019 over 2018?

Christopher Schroeder:  I think that the revenue for the whole state will be up this year because you're definitely seeing an increase in traffic and an increase in licensed retailers from the 2018 quantity. But it definitely affects our revenue as an individual brand where we have fewer stores to sell to you than we had two to three months ago. We're competing against companies that might be better capitalized, or companies that have more consumer mind share, because they're older. In an environment where you have four to 6000 stores, you can set a reasonable goal like 10% market penetration and think that you're shooting for 400 stores, in this case, 10% market penetration, 60 stores and it's not really enough to make the brand work. To give you a sense right now, we're in about 120 stores out of those 600. I think the one thing that every person in the industry would agree on is that as a state, we just need more licensed retailers to be selling licensed cannabis products.

Blaine: You said that the well finance operators make this more complicated. I'll have to dig into that. They have more money, so they are able to maybe potentially artificially drive cost out. Is that the main factor that makes it complicated? What other advantages to the well-financed operators have?

Christopher Schroeder:  Well, I think there's a few advantages. They can definitely compete on price and driving the prices down. However, I think that a good quality product can generally hold its price point regardless. I think one of the bigger challenges is they have a lot of infrastructure optimization. They usually have a larger footprint. Maybe they have more skews that they can amortize their costs over. They generally have bigger marketing budgets, and so they're able to participate in some newer practices such as slotting fees, or paying for promotional weekends. These are tactics that we see in more mature industries. We don't always see them in emerging industries. It makes it a little bit tougher to level the playing field. But brands like ours, we focus a lot on the grassroots word of mouth marketing, and doing really creative things to grow our company. I think ultimately, those things can help cultivate a stronger sense of community within our customer base.

We're hopeful, but it definitely creates a challenging environment where you're seeing a lot of consolidation, a lot of companies selling and merging, and being acquired, and part of that is to share resources, and that totally makes sense. As a matter of fact, for our own factory, which is about 2500 square feet in San Francisco, we're having conversations right now with co-packing other brands to help them get to market in a more cost effective way and to help us amortize some of our overhead.

Blaine:  You mentioned two things I want to learn more about. One was slotting fees. I know I've heard a lot of people mentioned that. It really just means the ability to pay the retailer to put your stuff on their shelves. I love to get a sense of what are those look like?  What are the rates on that? How much does it cost? How much shelf space are retailers selling to brands to lock down in their facility versus just basing their purchasing decisions based off customer demand?

Christopher Schroeder:  Yeah, the slotting fees, I've seen a range anywhere from $1000 to $6,000 a month. We've been lucky enough to be able to be placed on shelves, even without slotting fees because of the quality and uniqueness of our product. We focus on completely organic ingredients, single origin ingredients, we make vegan products and we make products that don't have any chemicals, preservatives or fillers. The slotting fees  range from just getting your product on the shelf, to getting marketing space where you can put up branded POS displays, shelf displays, and call customers attention to your products a lot more.  You can take, for example, a store that has a $4,000 a month slotting fee where we may actually be on the shelf next to those products. But the products they're paying the fee may get access to doing really custom displays, doing large posters on the wall, and there's even some cases in which retailers in California have been charging fees in order to have access to train their staff or to do any customer facing demos.

I think in general, I understand that the market is going to change and evolve and people are going to try things and if people from well capitalized companies are willing to pay then there's going to be a market for that. I do think that where we should draw the line as a community is withholding the ability to educate staff and customers unless you pay to do that, because that's really just service for everyone that walks in the store of that dispensary. If you're going to carry your product, you should want your customers to know about the product and want your staff to be educated. We're not seeing a ton of that. We're not seeing it across the board. But it definitely unlocks what I would call like premium shelf space or premium marketing opportunities within stores. Some of that I think is unavoidable, and some of that, I think, is also not sustainable. I suspect in Q1, you're going to see a handful of the companies that are currently paying slotting fees, run out of the marketing capital to continue to do so.

Blaine:  Yeah, I mean, look at all the layoffs that just happened with some of the biggest companies. I agree with you, I think that lack of capital that they're going through is going see itself in the slotting fees.

Christopher Schroeder:  I saw more than 700 layoffs in the state last month, which is pretty crazy when you think about this being a new hot industry. You're seeing that the regulatory structure is not making it sustainable for even well capitalized brands to keep the workforce that they hired.

Blaine:  Yeah, I agree. So, you're the scrappy startup, you're selling the premium product, and you were mentioning some marketing tactics, kind of like Guerilla marketing. I've seen it personally. It's really just like an emotional thing rather than even just a particular billboard or anything. It's kind of like grabbing the heart of the community. Do you want to just like this some big wins you've had or just tactics you've used that you're like, this was awesome to do. It could be an event you were involved with. It could be like a program you spun up, just know how scrappy brands are making themselves visible.

Christopher Schroeder:  Yeah, I mean, the first thing we did that made a really big splash was we were the first cannabis brand in the country to form a co-branded partnership with a non-cannabis company. As a brand new, scrappy startup give us a lot of credibility in lieu of money. Partnering of the Ritual was pretty cool because it was Ritual, also telling they're really large customer base. Hey, cannabis is okay. It's something that we think is acceptable, and it's something that you can add to products like ours. I mentioned earlier on the podcast that word of mouth and grassroots marketing has worked really well with us into that light. We've done a lot of what I would call underground events or events where you're doing educational marketing to new consumers who are really curious. I think that is really important.

Another thing that we've done is focus on a lot of underground and grassroots sort of private events, where you're getting access to talk to customers and educate them directly. I think one of the most important things that any of us can do in the industry is focus on educating consumers who are not using cannabis today and making them feel comfortable to walk into dispensary and buy the products. We also have done a great deal of work focusing on delivery partners like Sava, which is a local San Francisco delivery service, Goddess Delivers in LA. Those are things that we think are important because if you're not using cannabis today, it's a big barrier for you to necessarily want to go into dispensary and feel like you have to have a base level of education. If I can go to a private event and stand behind a table and show you the products that we make and tell you, you just have to click a button and this can be delivered to your house tomorrow, it really opens up the door for people who maybe don't have a base level of comfort to feel comfortable at experimenting.

Blaine:  That's interesting you mentioned in delivery. I'd love to get a landscape of that.  You said that there's 600 retailers. Does that include delivery and dispensary?

Christopher Schroeder:  It does, yeah. Delivery has its own set of challenges. It's got a really high cost of compliance and infrastructure because of course, they can't use traditional shipping services. Everything has to be delivered from a compliant and licensed delivery van. We think that that is going to show the most growth over time. They have different challenges but they also have the ability to do outdoor and print marketing campaigns that they can actually measure much more easily and see, am I seeing ROI from these marketing initiatives where it might be much harder for a brick and mortar store to quantify in the same way.

Blaine:  What percentage do you think of the market is delivery versus in store retail purchases right now?

Christopher Schroeder:  I don't really know. But I would say probably just like, somewhere between 15 and 25% of the market is probably delivery. I think that you're going to see that grow, especially when you consider that one of the biggest hurdles to legalization is 50% of California has a commercial cannabis ban at the county level. So that means that 50% of people live in counties that have disallowed commercial cannabis to exist in the state but those counties can't disallow delivery to happen. So delivery partners do get an advantage in the sense that they can service areas where there are no stores. They're the backbone of making cannabis truly available to the whole state until we make some legislative changes. There's some cool legislation that's on the table right now that may, for example, force a county, who had a majority of voters approved Prop 64 to approve some sort of commercial cannabis measure. We're also seeing some counties who banded less out of ideological reasons, and more out of a wait and see reasons who are now saying, okay, well, San Francisco, L.A. some of these cities that had commercial cannabis for two years, it looks like it's going okay. We're now passing some legislation to allow dispensaries to open in 2020. I think it is getting there little by little, but it's facing some pretty unprecedented challenges that are really starting at the regulatory level.

Blaine: I'd love to back it up a little bit. So I have a good sense of the current state of the market. It's really all about licensing, compliance, figuring things out, migrating to this fully compliant operation. You had something really interesting happened to you, and that is that you had to spin up your own production facility? I could only imagine banking on doing a co-packing deal and then having to do that. Can I get some details on that? How long did you work with the co-packer before you realize you had to swap over? How long did it take you to get your own facility up and running and get that first sale out the door?

Christopher Schroeder:  Yeah, I mean, it really only took us two production batches to decide that it wasn't going to work with co-packing. I would say that admittedly, ready to drink coffee is probably one of the hardest things that we could have chosen to do. Beverages in general were new and had a lot of complications at the time. But once we made the decision, it definitely impacted our entire business plan and business model.  This industry is all about just pivoting, shifting and adapting. We leveraged our network of people and we found basically a closet that we could sublease from Sava that was doing delivery at the time in 2017. We got a cold brew factory spun up in about three weeks. Me and my partner Clayton, and he comes from a production and lab sciences background, and that got us in market with our first products that we were making on our own really quickly.

The big shift and the biggest challenge was moving from that initial very small space to our own licensed facility. That involved things that I didn't personally have experienced with before like understanding commercial real estate, leasing structures. You were doing that all in environment while you had some framework at the local level here in San Francisco. So we knew some things like I hadn't had the space locked in by a certain date to be able to get a license. At the time that we were signing a commercial cannabis lease, we had not yet seen the final regulations from the state. So you're taking a really big risk thing. I'm going to sign a commercial lease for three to five years based on the regulatory structure that the city says that it's rolling out, while not knowing what the state regulatory structure is, and whether any of that would supersede it.

The good news is that the way that the state wrote the regulations, essentially local authority almost always supersedes the state authority. They have the power to make things a little bit stricter or a little bit more lacks in terms of, for example, zoning requirements. In a city like San Francisco, it's a pretty complicated city to navigate and might as well be a small state. But we had a really, really awesome head of Office of Cannabis here in San Francisco named Nicole Elliott. She had this Herculean task of actually pulling together all the regulators in San Francisco, quickly getting them on board, and having these inspection sweeps where the entire regulatory board would come through and inspect your facility.

I think the fact that there is a cannabis industry here is largely a testament to the hard work that she and Ray and others in Office of Cannabis did really quickly. That said, it came with basically a quadrupled overhead costs once you realize you have to pay for your own factory, build out costs, and then there's a lot of things that people don't think about, like our workers comp is 15 times more expensive for our cannabis company than it is for our non-cannabis company. Just because cannabis is involved. It can be doing exactly the same thing. There's a lot of things like that. There's add up over and over again.

Blaine:  Hell yeah, Nicole. A shout out to an actual regulator that's kicking ass. I love to hear that. Yeah, regulations are so crazy. Honestly, I feel like that's one thing it's under discussed is some of the regulator's that do go over the top and like over perform. They are the unsung hero sometimes.

Christopher Schroeder:  Sure. I mean, Nicole Elliott did a ton of work and then essentially got promoted to reporting directly to Gavin Newsom as a cannabis oversight task force leader. She left the office in really good hands with Ray Law, and there's Eugene and a few other awesome people at the Office of Cannabis who've really just done a great job of fostering a positive environment here in San Francisco. That's really not an easy feat. I mean, the supervisors were not necessarily pro cannabis. This is really a lot of hard work from our Office of Cannabis here that changed their mind, and without having an Office of Cannabis, I suspect San Francisco would be in the same place a lot of cities were, which are, we don't know about cannabis,  we're just going say no for now.

Blaine:  Yeah, these defaults are no. So okay, let's put on different hat for you. A lot of the problems are really just regulation based. Obviously, if this is just like a food industry, be such a different landscape, everything will be so much easier, so different. Obviously, making those regulatory decisions is not easy on any side of the equation. You have the operators, you have the law, you have the government, you have tax organizations, so many organizations involved. Why would you change, if you could change one thing, if you were suddenly in charge of all the regulations in California?

Christopher Schroeder: I never thought I would say this before I was running my own business. Honestly, the one thing I would change is taxes. I would treat the cannabis industry not like a cash grab for money and revenue at the state level, but instead, I would treat it like the state treats other emerging industries. I would give us tax incentives and tax breaks and things that incentivize us to keep our business here in the state and in these specific cities. I mean, the effective tax rate to a customer on a product they buy is about 25%, and that's going up in January. You look at other industries, like let's see tech, for example, where five to seven years ago would be considered an emerging industry.  

Cities like San Francisco, make tax breaks and make incentives to draw that business here. Instead, we have a state that's over taxing, and they're not just taxing the final product. They're taxing the cultivation, the extraction, the manufacturing, the retail, and they're taxing it at a really, really high rate, and that's in addition to sales tax. So once you add sales tax, most customers are paying upwards of 30% for their product. I don't think that people know that. I think that if customers knew that they could help be more vocal to put pressure on the state to say, hey, I actually don't want to pay 3.50 in taxes on a $10 item.

Blaine:  Yeah. Just to give a quick breakdown for the listeners, there's the cultivation tax, where you tax the actual plant itself for how much you grow based on weight. Then there's the excise taxes the distributor to the retailer, and then even the county will tax the distributor to the retailer. Then also you have the retail level tax as well. I actually think 30% might be a way understatement because it's 24% at the distribution level, then you have the cultivation tax, then you have the retail tax, then your county taxes. Isn't that more like the 40 or 50% range?

Christopher Schroeder:  Yeah, For example, when I wholesale something for $2.75, by the time it gets to customer, it's 9.50. On that $2.75 product, I'm making somewhere between 90 and $1.20 per unit. Everyone has to make their margin, but every step is being taxed. It's pretty crazy and it affects products like ours in a particularly interesting way because we focus on all low dose products. There's actually a big report that just got released yesterday, where an authority made sort of a tax audit and recommendation to the state. They're recommending that the state move to a potency based taxation system rather than weight or quantity which should be super awesome for a company like ours that's making low dose products, it would be awesome for cultivators. It makes a lot of sense. My hundred milligram... Well, I guess, all products have to be capped at 100 milligrams per unit. But regardless of how many milligrams you put per piece or per package, you're taxed at the same rate. As you said, yes, it's really high once you add in local taxes and sales tax.

Blaine:  It gets pretty out of control. Cool. So let's look forward. The deal regulations are always going to be dealing with it. It's going to be crazy. We'll get through this. What's your main objectives for 2020?

Christopher Schroeder:  For 2020, we just want to get more consumers feeling excited and comfortable to try cannabis. We want to get out there and talk to people directly. We want to push our delivery partners and some of our direct to consumer partners to help us with that mission. So far since launching the company, we've gotten countless moms, grandmas, and uncles, and aunts to use cannabis for the very first time, and that wasn't something that I necessarily had in mind when I started the company. It's been a really, really cool outcome because we make these really low dose, high quality, healthy edibles that people can feel good about putting in their body. We've been able to get people that had traditionally been really opposed to cannabis to try it.

I think the biggest objective I have is to really take this back to the plant, and the movement, and the community and just say, hey, in order for this to work, we just really want to expand the community around cannabis advocacy, and having new people come in and try it, and break some of their stereotypes, and find a way where cannabis fits in their daily life, and helps improve the quality of their life is really, really exciting. Really at the core of why we did this. Of all the challenges we've had, that's probably the most exciting thing is to remember that we started this as a mission driven business and we're seeing that part of our business be really, really successful.

Blaine: Awesome. I'd like just answer one more question about kind of like Somatik as a product. I'd love to dig into kind of the R&D side of making your product lines. You started with coffee, tell me about Espresso Bites. I'm pretty sure you even have a CBD product because the CBD craze are getting online. I'd like to know how do you choose which product to make next, like why did you choose CBD? How do you execute bucks?

Christopher Schroeder:  Yeah, I mean, the name of the company, Somatik means Mind Body balance. We're always looking towards what kind of products you're going to help people restore the balance in their life. One of the main focuses of the company is reducing your stress and anxiety to improve your well-being. That gives us like a guiding light to think about what type of products do we want. Another huge ethos of our company is to have a completely transparent supply chain of high quality products. When we started with coffee, we did that because it was a nice parallel to the connoisseur aspect of craft cannabis, and adding chocolate was kind of a no brainer for the same reason. There's just so many parallels between the plant of cannabis coffee chocolate, how you grow it, how the terroir of where it's grown, and why using certain techniques affects the flavor outcome.

We really wanted to stay focused on that kind of higher level connoisseur aspect because I think that opens the door to education. Once we've picked the kind of product classes that we wanted to go into, you're looking a little bit at trend and what's working in the market but you're also looking at mood affect an outcome and you're trying to make products that are going to help people in their daily life. For us it was a no brainer to start with the chocolate covered coffee bean because that helped us to leverage our relationship with Ritual.

We expanded to CBD dominant, Goji berry. This year, we added a chocolate covered golden Berry, which is also called an Incan ground barrier Peruvian berry, and that's a one to one CBD. Also this year, we've added a whole lot of other plant herbs to the products. We focused on a class of families called adaptogens. The purpose of that was really to broaden the conversation around plant medicine and showcase that there are a lot of other types of plants and medicines that work really synergistically together.

We'll usually prototype a bunch of different things that have different ratios that we're going for a certain mood outcome. We're really trying to say, okay, I want a product that helps people relax. I want a product that helps people feel uplifted and energetic. I want a product that helps people feel balanced, and productive, and focused. What type of product is going to help me achieve that? That's kind of how we think about product development, and then there's the whole slew of R&D and actually making that and seeing if you can get that outcome.

Blaine:  I like the consumer centric lens on that. I mean, here at Distru we try to always stay focused on the user and what they need. So, I like to hear that it's not just marketing trends. It's actually like adaptogens. I've never heard of that. I'm excited to learn about that. I wonder how it's going affect my brain, like the sounds fun. Super cool stuff.

Christopher Schroeder:  Yeah, it's kind of like verging on nootropics. It's a little bit. Someone's used the term mood hacking before and I love that term because it really easily conveys the idea behind like, okay, if I take different ratios of cannabinoids, I take other herbs, they make some of super foods. I can actually hack my way into the mood that I need. In this busy corporate environment, and a really competitive city like San Francisco, I think it's really important to give people release valves that help them get through their day and manage their stress while staying really productive and successful. The one message that I have if I was talking to someone brand new is that you can be really successful and be a daily cannabis user. In fact, if you are successful and a daily cannabis user, please talk about that and let other people know because as far as the industries come, we are still really fighting for normalization in a very big way, and that only comes from people who are actually using the product, talking about it and evangelizing it to their friends.

Blaine:  Yeah, I completely agree there. I mean, I can personally say, it goes on and off. But for a lot of my life, especially in the later last 10 years, I've been a daily user. So yeah, big proponent of that as well. I think it's important to get out the message that, hey, you can do big things and the ideal user. I love that word, mood hacking, by the way. That's great. When you think about it, it's like when you drink regular coffee and you drink beer, it's like you're already mood hacking. Now you're just putting like a label on it. So now you're conscious about it. You're not just saying, I'm going to drink a beer because it makes me feel away. You're saying like, no, I want to be happy, and this will get me there. That's kind of interesting I think about.

Christopher Schroeder:  Yeah, totally. I mean, I have like a regimen. I start my day with this. This is my good afternoon like get over the hump, especially if I have productivity things I have to get done. We have like a chill and relax kind of end the day product that focuses on reduction of pain and anxiety. It's pretty exciting to be in this new world. Also to remind people that these are plants and plants are medicine. That's one of the really exciting things is we don't necessarily have to turn to the industrial, pharmaceutical complex to get treatment to our daily lives. I think one of the reasons I think cannabis is going to be really successful is it's sort of a correction and backlash to the opiate crisis, which is very much I think, driven by corporate profits over actually treating people. Cannabis has always been about people and plants first and foremost. So I think companies like yours and mine, it's important to keep that message alive because it'll stay that way if we collectively consciously work on it.

Blaine: Yeah, I mean, even just a few times I've talked to people that I'm like stopped using Opioids or even avoided Opioids because of cannabis. Like, even if it's just one person. I know I've talked to at least 20 that I've had that some story along the lines, but even just one, that's already a win for me. Yeah, I completely agree on the change is going to bring to certain Opioids in pharma. I don't want to shoot the pharma industry down. Obviously, they do some great things. But in this case, I think it needs to happen. It's not like a, can happen and it could just needs to happen. Cool. Well, this is awesome. Interviewing you is great. You gave us so much insight. We're about to end on a lighter note of what is your daily cannabis regimen and then you can kind of cast us out.

Christopher Schroeder:  Yeah, we'll also quick shout out to District and making great software that really helps all of us operators regulate this environment. So you know, thanks for building something that works for us with your customers in mind. I think that really shows. As far as my daily cannabis regimen, I usually start the day with a micro dose of one of our sparks. I usually use like our golden berry because it's a one to one with some maca root. It keeps me pretty focused. About three to five times a week, I'll smoke some flower, usually late afternoon, early evening. That's kind of my daily regimen.  I'll pair cannabis with any physical activity I'm doing. I love smoking a joint before a hike or a yoga class. It really just helps you get in your body and find that balance and kind of hold some of your daily stresses that day. I definitely recommend people play around with micro dosing and see if it could slide into your daily life.

Blaine: Awesome. Any last words? Thank you either way. It's awesome talking to you.

Christopher Schroeder:  Yeah, thank you so much, Blaine. Talk to you soon. If anyone has any questions, they can always reach out to me directly at chris@somatik.us.

Blaine: Cool. All right. See you, Chris. Thank you everyone for listening.

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