SOMETHING TO CONSIDER

What’s Behind the Baby Formula Shortage?

BY GARY LATTA

For months, the alarming U.S. baby formula shortage has had parents scrambling to find product on near empty shelves at stores. The meltdown of the infant formula industry has set in motion significant food industry, supply chain and political analysis explaining our dilemma to avoid future tragedies. Most industry observers agree as to the causes of the shortage. We will look at some of these issues and how dairy milk plays a part in the baby formula industry.

Most baby food formula is made with cow’s milk that has been modified to simulate human breast milk. These formulas furnish the correct balance of nutrients and digestive properties for the infant. The American Academy of Pediatrics and the World Health Organization both recommend that mother’s milk is best for newborn babies. As the child gets older, or if the mother can’t breast feed, then fortified formula is the next best option. It is recommended that infants stay on formula for the first 12 months of life and then be weaned onto whole cow’s milk.

According to pediatricians and parents, the top infant formula brands in the U.S. are Similac Pro-Advance, Enfamil NeuroPro and Earth’s Best Organic Dairy Infant Formula. All are milk-based. Infant formulas undergo significant processing and addition of nutrients before they can be consumed. Cow’s milk contains relatively high concentrations of protein and minerals that can stress a baby’s system. Cow’s milk also lacks the necessary amounts of iron, Vitamin C and other nutrients needed by infants. So, formula manufacturers meticulously add in and remove components to create their finished product. Obviously, the baby formula manufacturing industry is highly regulated.

During the recent shortage, some parents have attempted to create their own formula or switch to cow’s milk earlier than recommended. Homemade is not a good idea. Today’s infant formula is a careful blend of proteins, carbohydrates, fats, vitamins and minerals. These formulas are exceptionally regulated and in a constant state of development in search of a product that most closely resembles human milk. Dr. Hillary Bashaw, a pediatric scientist and professor at Emory University College of Medicine, points out that all formulas must be in the ranges allowed by federal law. There are minimum levels for 29 nutrients and maximum levels for nine others. The federal regulations were tightened because of the Infant Formula Act of 1980 and then updated in 1986.

Numerous agencies and critics have come forward with their assessments of the U.S. baby formula industry. Nearly all acknowledge the causes of the problem and most agree on what needs to be done to fix it. Many regard the industry be an “oligopoly” with a few manufacturers creating very similar products in a marketplace that lacks vigorous competition. Investopedia describes an oligopoly as a market structure with a small number of firms, none of which can keep the others

from having significant influence that exerts significant control over a given market, including limiting new entrants. The U.S. has four major manufacturers: Abbot, Mead Johnson Nutrition, Nestle USA and Perrigo. Collectively, they comprise a 90% share of U.S. baby formula production. The largest of these is Abbot, responsible for around 43% of formula sales in the U.S. and the sole supplier to the Women, Infants, and Children (WIC) contracts in 49 states. After the Abbot plant in Michigan shut down in February due to contamination that was later linked to nine infant deaths and subsequent (and delayed) FDA inspections, the country lost 40% of its formula production overnight.

WIC is a social safety net program administered by the USDA Food and Nutrition Service that provides federal grants to states for supplemental foods, including infant formula. WIC is the largest purchaser of infant formula in the U.S., and almost half of the babies born here qualify for participation in the program. Most critics of the formula industry point to WIC as a major cause of the current dilemma. The program is limited to only domestic manufacturers. WIC state agencies authorize just one brand of U.S. manufactured formula for use in their state. This one state-authorized manufacturer issues that state a rebate on all its WIC purchases. Many critics and members of Congress now point to this setup as essentially creating a monopoly on all the formula sold through the program in that state. Since Abbot is by far the manufacturer of choice among 49 states, the shutdown of their plant sent shockwaves through the system.

Since the government purchases nearly half of all formula, it uses its buying power and elaborate rebate mechanisms to lower costs. Critics of the system claim these lower costs are far from being “free.” Formula manufacturers use massaged prices to state governments in return for an exclusive contract to do business in that state under WIC. For those that qualify for WIC benefits, formula is low-cost or free. If you are not receiving government assistance, infant formula is considerably more expensive. Critics claim that formula prices in Europe are half the cost of formula in the U.S. for those parents not receiving government assistance like WIC. Currently, Abbot, Nestle and Reckitt are the sole manufacturers authorized by the U.S. government to furnish formula through the WIC program.

The WIC program reimburses formula manufacturers for 15% of its wholesale cost. The federal government issues grant money to each individual state, which in turn contracts with one of the three approved national manufacturers. The necessity of WIC is without question. However, the way the program is designed has the inadvertent consequences of forming a monopoly with the state. In testimony June 15 before the Senate

Judiciary Committee’s Subcommittee on Competition Policy, Antitrust, and Consumer Rights on the topic of “Baby Formula and Beyond: The Impact of Consolidation on Families and Consumers,” Scott Lincicome of the CATO Institute stated that research shows WIC’s large exclusive contracts assist winning bidders to gain market share and raise prices in the non-WIC funded market, thus becoming the dominant supplier in the state.

To help alleviate the supply shortage, President Joe Biden invoked the Defense Production Act on May 18 to ensure manufacturers obtain raw materials and consumables needed to further accelerate production of infant formula. The next day, Biden announced the first Operation Fly Formula Mission to use DOD-contracted commercial aircraft to pick up overseas infant formula that meets U.S. health and safety standards to get supply on store shelves. The U.S. is currently flying in formula from Europe, Australia and Mexico. Until now, about 98% of the infant formula consumed in the U.S. is domestically produced. Importing baby formula to the U.S. is allowed by law but is infrequent, partially by design. In a typical year, a mere 2% of formula is imported from other countries, such as Mexico, Ireland, the Netherlands, Chile and Austria.

High import tariffs, complex policies and FDA labeling requirements serve to protect the U.S. formula industry from international competitors. While many of the forementioned countries make a quality product that meets FDA’s nutrition standards, the steep 17% tariffs and differences in labeling requirements impede imports. There is little incentive for other countries to export infant formula to the U.S. The infant formula industry is more regulated than other foods in the U.S. and more so than the formula industries of other countries. Some question whether such onerous regulations are necessary, and whether it serves to limit the number of industry participants. Is heavy oversight serving to discourage new entrants and investment into this market? Recently, there has been a new entrant in the U.S. infant formula market, the first in 15 years. It took the new company, named ByHeart, nearly $200 million and five years to begin production.

Shortages of essential formula stresses parents, especially moms who cannot breast feed for various reasons. Shortages also pose a risk to infants, particularly those who depend on special formula types due to unique medical conditions, complications or allergies. Unlike most foods that have substitutes, infant formula is unique with little to no alternative. In recent months, there has been an effort by many groups, including Congress, to examine the infant formula industry and possibly restructure the market to avoid nationwide collapse if one facility shuts down.

Senate committees and other federal representatives are exploring ways the WIC program could be modified to improve how it sources formula. Committees are also looking to diversify the system’s supply chain and perhaps disassemble some of the oligopolistic nature of the domestic market. The Congressional Research Service recently published an insight report, Tariffs, and the Infant Formula Shortage. This indicated that few players, the WIC program’s sole-sourcing contracting structure and FDA’s strict labeling requirements likely make the U.S. an unattractive market for foreign manufacturers — especially for lower-cost formula. The CRS report concluded that non-tariff barriers are likely playing a bigger role than tariffs in foreign manufacturers’ decision to not enter the U.S. market.

U.S. policies that tend to restrict domestic competition and limit imports from abroad have promoted the dominance of a few players. Now, the challenge for U.S policymakers is to reform, revise and restructure the system. Let us hope this can be accomplished without adding more layers of bureaucracy and regulations.

Gary Latta is a dairy product specialist consultant for the Northeast Dairy Foods Association, Inc. He has more than 30 years of experience in providing economic analysis, statistics and information to the dairy processing industry.