Imagine you want to start a business. You’ve done your legwork, developed a solid business plan, and you’re ready to enter the marketplace when someone tells you that you can only open your business if you win a lottery among other entrepreneurs – many of whom are far less likely to operate successful businesses than you are. Sounds crazy, right? Unfortunately, that’s the reality that many marijuana businesses face in multiple states.

Both Arizona and Washington use some kind of lottery system to award marijuana licenses to businesses. In addition, some states allow municipalities to approve or ban certain types of marijuana-related businesses from operating within their borders. These municipalities grant their own licenses to marijuana businesses, and some of them, like Long Beach and Santa Ana in California and Grand Rapids, Michigan, use lottery systems, too.

In the marijuana industry, like all industries, all factors are not equal when an entrepreneur decides to open a business. There are so many things to take into consideration when evaluating the potential for a new business’ success – from having the right leadership and understanding laws, finance, marketing, and more to managing expenses, inventory, employees, and customers. When a state is building a new industry that is expected to be very profitable, it makes sense to allow the most qualified businesses with the greatest chance for success to have an opportunity to participate. With marijuana license lotteries, the concept of fair competition is gone.

Let’s take a closer look at what’s happening.

The Licensing Process When the Number of Marijuana Licenses is Restricted

Many states restrict the number of licenses granted to dispensaries, cultivators, processors, and testing labs. Some restrict the number of all of these license types while others only restrict the number of specific types of licenses – most often the number of dispensary licenses. States use one of three different processes to grant those licenses: competitive, lottery, or qualified lottery.

Competitive

With the competitive licensing process, marijuana businesses submit applications (with application fees) that are rated based on quality in a variety of areas such as proof of capitalization, inventory control plan, operations plan, detailed policies and procedures, security plan, criminal record, and local support. Every application is rated using the same criteria, and applicants with the highest scores are granted licenses. Yes, there can be problems with how applications are rated as we recently saw in Pennsylvania and Florida, but this is still the process used by most states that have approved medical and/or recreational marijuana.

Lottery

In the lottery process (like the one used in Arizona) marijuana businesses submit applications with their application fees. All applications that meet the minimum requirements (e.g., they don’t violate the required buffer zone between the business and a school) are put into a lottery. Winners are picked at random with little or no consideration of qualifications. Those winners receive licenses.

Qualified Lottery

A qualified lottery works like a regular lottery where qualifying applications are chosen at random and those applicants receive licenses. However, the qualifying criteria is much more specific and strict than in a regular lottery. Typically, applicants have to meet high standards to make it into the lottery. Washington State uses a qualified lottery system, which is a hybrid between the competitive and lottery processes.

The Problem with Marijuana License Processes

Aside from the obvious problem of the most qualified businesses not always getting licenses when lotteries are used, there is also the problem of awarding licenses based on luck rather than merit. With a lottery, you’re (hopefully) getting a business that meets minimum qualifications rather than one that you’re certain did the most planning to build what can become a sustainable business.

Consider this – seven months after 20 marijuana license applicants were granted dispensary licenses by lottery in Santa Ana, California, only two of those dispensaries had opened. Would the story be different if a competitive application process was used?

Another problem with the lottery system is the potential for a small group of businesses with multiple submitted applications winning the majority of the available licenses. As a result, a small number of companies will dominate the industry. That’s exactly what happened in Saskatchewan, Canada. In total, 1,350 applications were submitted for 51 cannabis retail store permits. When the lottery ended, five companies received 17 of the permits, which means one-third of the licenses are shared between those five companies.

However, the competitive process isn’t perfect either. Ratings are subjective and sometimes, applicants gather large sums of money and political favors to increase their chances of securing licenses. It’s far from a perfect system, and it’s wrought with lawsuits. For some states, a lottery system is viewed as a way to insulate the state from lawsuits. However, the lottery process isn’t immune to lawsuits either. For example, when Florida proposed its own marijuana license lottery in 2014, the state was sued and ultimately gave up on the lottery system.

States that use a lottery system do so because the number of marijuana licenses available in those states is restricted. In a young, growing industry, being first to market (or early to market) presents a significant advantage. While it’s probably true that most states restricting the number of marijuana licenses today will probably add more licenses in the future (and give more businesses a chance to enter the industry), for now, a restricted number of licenses means an oligopoly is forming in many states.

This is in stark contrast to states that do not restrict the number of marijuana licenses. For example, Colorado doesn’t restrict the number of licenses and has granted hundreds of them. Ultimately, the market will decide which businesses will last in Colorado. In fact, it’s already happening. In Oregon, some marijuana retailers are consolidating after legalization, overproduction, a decline in prices, and a weakened market left them with tighter margins.

Think of it this way. In Connecticut, there are nine dispensary marijuana licenses per 400,000 residents. In Colorado, there are 528 dispensary marijuana licenses per 10,416 residents. Yes, the Colorado market is more mature and residents voted to legalize recreational marijuana last year while only medical marijuana is legal in Connecticut. Naturally, Colorado has more dispensaries at this time. However, the question is this. In which state will the free market decide which businesses make it? If you answered “Colorado,” you’re right.

Originally published 10/6/17. Updated 11/16/18.