Firms’ strategic reactions to nutritional policies: Understand and derive a set of optimal policies

Cardiovascular diseases and cancer constitute almost two-thirds of diseases in industrial countries. A large number of these (chronic) diseases are due to lifestyle-related risk factors, among them poor dietary habits such as excessive intakes of salt, carbohydrates, and fats, in addition to insufficient intakes of fruits and vegetables. According to the World Health Organization, preventing these diet-related risk factors in combination with actions reducing physical inactivity and tobacco use could lead to an increase in the average life expectancy by three to five years in high-income countries.

Information campaigns leading to health inequalities?

Governments and public health agencies have been implementing policies to promote preventive behavior over the past years, such as information campaigns and food product labeling. These policies have not had much positive impact yet. They are even suspected to increase health inequalities as lower-educated individuals respond less to information policy.

Given the modest impacts of information-based policies, public health agencies are now considering other policies to modify the market environment, ranging from price policies to nutrition-related standards. The overall goal is to facilitate healthier food choices, even among non-health-sensitive consumers.

Food industry should create better food environment

Public health agencies and policy makers urge the food industry to favor a better food environment. This can be done through changes in the quality and variety of foods and in advertising and marketing.

In the design of nutritional policies, it is important to anticipate the reaction of food firms. Companies may amplify or weaken their impact or they affect the health outcomes of food consumption through their decisions about the quality and variety of foods.

Generally, firms base their response to nutritional policies on market segmentation and product differentiation. Nutrition and health claims, such as ‘rich in fibers’, ‘light in sugar’, ‘enriched in vitamins’, target health-sensitive consumers who have higher willingness to pay for additional health functions in foods.

Weak incentives to reformulate products

Market shares for those products remain relatively small at approximately 20 percent. The nutritional quality of food in the remaining part of the market is more contrasted. Therefore, public health agencies urge the food industry to commit, in individual or collective agreements, to reduce the level of ‘bad’ nutrients in food products. Although some brands have moved quite significantly, firms have weak incentives to enter into a product reformulation strategy to improve the nutritional quality of products.

There are several possible reasons for this:

Reformulation will likely increase production costs. Changes in ingredients might affect variable costs; new recipes might require development expenditures.
Asymmetry of information between producers and consumers: Consumers often do not know about a product’s quality, as nutrient fact panels on food packages are difficult to understand. This information problem results in a breakdown in the market for processed foods, leading to the ‘McDonald’s equilibrium’ in which low quality covers the entire market. 

• ‘Addiction assumption’: If the consumption of added sugars or fat in foods leads to addictive behaviors, companies have strong incentives to continue to market such foods. This assumption is plausible but remains controversial.
• Consumers’ expectations: Although consumers do not always perceive moderate changes in salt or fat content, once they know, many consumers reject the reformulated product because they believe that ‘healthier’ means ‘less tasty’.

How to force quality improvement

To force food quality improvements, policy makers may use various instruments:

Implementing minimum quality standards. The theoretical literature on minimum quality standards provides mixed insights. In a simple setting, in which differentiation between products relies on a single characteristic, they seem to be quite efficient.  For example, the ban upon trans-fatty acid (TFA) in New York State and in Denmark, where a mandatory maximum content of TFA was implemented in 2004, seems to have had positive effects. In a more complex setting, however, in which products are differentiated along multiple characteristics, setting minimum quality standards might be counterproductive, even if the market underprovides quality.

Other tools such as food taxes can influence the quality chosen by firms. The regulator might define a quality threshold. Products that have a quality higher than the threshold are not taxed, lower are. Such a policy seems to be efficient, as a firm prefers to reformulate its product to avoid the tax, leading to positive results for health and welfare.

The salt example

Elevated dietary salt intake is an established risk factor for high blood pressure and cardiovascular events. The WHO has recognized excess dietary salt intake as a global problem and set a worldwide target of less than 5 g salt per day per person.

However, high salt content generally makes food more palatable. Reducing salt in foods may therefore alter the product’s taste and be perceived negatively by consumers. Most consumers are not really aware of the health impacts of high salt intakes, the majority is unaware of health recommendations and one-third is not interested in salt reduction.

Voluntary commitments by firms to improve the nutritional quality of foods remain modest. Firms’ reluctance to decrease the salt content in foods echoes consumers’ resistance.  Moreover, technological solutions that can be used to compensate for taste modification are imperfect, leading many consumers to appreciate the product less or even reject it. Finally, removing salt in foods may induce additional production costs.

Better understand firms’ strategic reactions to nutritional policies

Confronted with the limitations of information campaigns targeting consumers and the modest impact of voluntary commitments by firms, the WHO and some governments are considering more coercive interventions based on quality regulation and fiscal policies.

But how do companies react to market impacts under these conditions? Vincent Réquillart; “The main contribution of our analysis is to evaluate market impacts of alternative policies. We integrate strategic reactions of firms both in terms of prices and product characteristics. Thus, we consider linkages between the nutritional quality of food products and their taste characteristics. This complex relationship between the taste and health characteristics of a product is a key point in analyzing firms’ strategy. In addition, we estimate social welfare impacts.”

In this context, SUSFANS researchers developed a model of product differentiation. They looked into two mono-product firms competing on price and product characteristics. Products are differentiated along a one-dimensional characteristic, e.g., more or less salty. The position of a product on this axis may affect consumers’ utility in two ways: through its health impact, and through its taste due to the content in salt.

Important consumer information policies

Using this framework, the researchers compare the impact of three policies - imposing a minimum quality standard; setting an excise tax based on the nutrient content of the two products; and setting an excise tax based on the nutrient content of the ‘bad’ product - on consumer demand, prices, product characteristics, a health indicator, and welfare.

“We show that firms respond differently to the three instruments, leading to different impacts on market and public health outcomes. Of the three policies we analyzed, we found that only the minimum quality standards policy and the linear excise tax on the low-quality product are effective in a general sense”, tells Réquillart. “The choice, however, between the two depends on the priorities of the regulator and on the consumers’ resistance to move away from their initial taste preferences. Finally, we show that policies intended to change the food market environment allow for greater health benefits and welfare than policies based solely on information campaigns.”
“Overall, our results have two important consequences for nutritional policy design. Whereas some policy makers are sometimes reluctant to go beyond consumer information and education interventions, our analysis suggests that policies targeting changes in food quality must always complement information policies.”

Standard-based policies might be preferable to fiscal policies

“A large part of the public debates related to nutrition and health policies has focused on fiscal interventions like fat tax, taxes on soft beverages. Our analysis does not suggest prioritizing such instruments in most cases”, tells Réquillart. “In fact, the tax policy is regressive, thus lowering the surplus of the less-health-conscious consumers while increasing the surplus of the more-health-conscious consumers. Moreover, we also show that if the tax rate is too high, firms’ strategic reactions may lead to unintended consequences”. Thus, an excessively high tax rate leads the low-quality firm to degrade the quality of its product, which leads to a strong negative impact on the health outcome of the policy.

It should be stressed that in most cases, standard-based policies should be prioritized. Practical difficulties of such policies that could however limit their implementation would have to be analyzed in greater detail.

 

 

Quality standards versus nutritional taxes: Health welfare impacts with strategic firms by Vincent Réquillart, Louis Georges Soler, Yu Zang