The Mexican soft drinks industry has been reeling this week following the new budget proposed by the Peña Nieto administration, including, among other reforms, a US$0.08/litre (Mx$1/litre) tax on "sugary" drinks. While taxes on soft drinks have been proposed and rejected in the past, this resolution is expected to pass in mid-November due to strong backing from the administration.
The tax is not out of character in Mexico, where the government has become more proactive in combating the growing prevalence of obesity and diabetes. During the 2012-2013 school year, the final phase of a regulation restricting what food items can be sold to children in schools went into effect. This law imposed restrictions on calories, sugar and fat content in meals sold to schoolchildren, as well as mandating the use of whole grains. Government actions such as these have become more important in light of an international focus on Mexico’s obesity crisis. A 2013 United Nations report found that Mexico had overtaken the United States as the country with the highest prevalence of obesity; which has been steadily increasing by more than a percentage point per year, from 27% in 2007 to 33% in 2012. All that said, it is unlikely that the tax will dramatically reduce soft drinks consumption overall in Mexico, where potable water is in short supply. Instead, it may cause a shift in purchasing behaviour between product categories.
The Devil is in the Details
The exact language of the Mexican “sugary” drink tax proposal is thus far somewhat vague, leaving drinks companies scrambling to determine their next move. "Sugar-sweetened" beverages will be subject to the tax, but drinks sweetened by artificial sweeteners and drinks naturally containing sugar (namely 100% fruit juice) will not be affected. Also yoghurt and milk drinks will not be affected as they have nutritive value and are not considered to be empty calories.
However it is not clear if there is a limit to the amount of sugar that is allowed per litre to avoid the tax or if drinks including any sugar will be subject to the tax. This is an important distinction for beverage companies who may try to avoid the tax by launching stevia sweetened products or reformulating their existing products to include stevia. Stevia is a natural sweetener so it avoids much of the stigma attached to artificial sweeteners. However, in many products, stevia is used in addition to a reduced amount of sugar in order to avoid the unpleasant aftertaste which is a common complaint of stevia. Furthermore, it is not clear exactly how the law will apply to powder and liquid concentrates – one of Mexico’s most important beverage categories due to the affordable nature of the product. If the per litre tax is found to apply to the reconstituted volumes of these beverages, these products will lose much of their inherent price advantage, particularly among price-sensitive low income consumers.
Near-Term Winners and Losers
Sales of larger pack sizes will likely be more heavily affected - the price of a 355 ml can of Coca-Cola sold at a convenience store will only increase from US$0.62 to US$0.65 (Mx$8 to Mx$8.35), an increase of 4%, probably not a change significant enough to discourage many impulse purchases. However, a 3.3 litre bottle of Big Cola will jump from US$1 to US$1.26 (Mx$12.9 to Mx$16.2), an increase of more than 25%, which may be significant enough to encourage consumers to rethink their purchases. This will affect standard carbonates the most, as more than 60% of carbonates are sold in packs larger than one litre, whereas pack sizes greater than one litre are rare among other beverage categories.
Full calorie concentrates are sure to take a huge hit. While the language of the tax is not entirely clear on this matter, it implies that concentrates will be taxed based on the litres of beverage their packs make. For example, a 25g pack of Tang is sold through a discounter in Mexico for US$0.19 (Mx$2.45) prior to the tax. This 25g pack makes 2 litres of ready-to-drink beverage, and therefore would be subject to a tax of up to US$0.16 (Mx$2), increasing the sales price by more than 80% to reach US$0.34 (Mx$4.45).
Growth of RTD tea has been very promising in recent years, with a volume CAGR of 26% between 2008 and 2013, as many consumers view this as being a healthier alternative to carbonates. However, standard RTD tea has similar sugar content to standard carbonates and therefore, instead of the 20-25% volume growth that was expected prior to the tax, growth could slow to single digits for full calorie RTD formats.
In the short term, we can expect companies to increase their promotion of "light" and "zero" products, particularly targeted towards lower income consumers, who will be the most affected by the tax and where these products have the lowest consumption currently. Despite advertising campaigns, this population has been slow to adopt lower calorie carbonates, and companies worry that if the tax is made law, this core consumer group may reduce their volume consumption entirely without substituting carbonates for any other products. Companies will want to promote their smaller pack sizes, ensuring strong distribution of these products through the expanding network of convenience stores throughout the country and through independent small grocers. Growth of products excluded from the tax, (zero calorie carbonates, concentrates, no-sugar added bottled water, light RTD tea and 100% juice) is expected to increase dramatically in 2014, with growth then decelerating through the forecast period as consumers become more accustomed to the new taxes and settle into adjusted consumption patterns.
In the medium term, companies will want to rethink their product portfolios, promoting or expanding their lines of flavoured waters (so long as flavoured waters no longer have added sugar so they can be exempt from the tax), offering more carbonates and RTD tea flavours that use non-sugar sweeteners (particularly Splenda or Stevia sweetened drinks as these have a healthier perception than aspartame), and expanding their selections of 100% juices.
It is unlikely that the tax will single-handedly turn the tide on obesity; the Mexican Secretary of Health estimates that a tax of 10% (comparable to the proposed tax) will reduce obesity by 8-9% over the next decade. However, this is part of a larger effort by the government to educate the Mexican consumer on what foods are healthy and which contribute to obesity. Changing behaviours takes time but these types of initiatives (sugary drinks tax, school snack regulations, encouraging exercise) incentivise healthy behaviour and should, in time, see rates of obesity start to decline. Until that happens however, Mexicans should expect to see more of these interventions, as the costs of obesity (and the resulting health problems) to the state are too high to be overlooked.