oversight

Infant Formula: Cost Containment and Competition in the WIC Program

Published by the Government Accountability Office on 1990-09-27.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                   011weisqp~   am. l~wesqplons,
                   Committee on Energy and Commerce,
                   House of Representatives

September   1990
                   INFANT FORMULA
                   Cost Containment and
                   Competition in the
                   WIC Program




GAO/HRD-90-122
GAO
      United States
      General Accounting Office
      Washington, D.C. 20548

      Human Resources Division

      B-240766

      September 27, 1990

      The Honorable John D. Dingell
      Chairman, Subcommittee on Oversight
        and Investigations
      Committee on Energy and Commerce
      House of Representatives

      Dear Mr. Chairman:

      This report responds to your request for information on infant formula
      cost-containment initiatives in the Special Supplemental Food Program
      for Women, Infants, and Children (WIG).This federal nutrition program
      served less than 50 percent of eligible women, infants, and children in
      the mid-1980s. To reach more of the unserved population, directors of
      WIGagencies developed strategies to reduce the cost of WIGfoods,
      targeting infant formula as the food likely to yield the greatest savings.

      The majority of WIGagencies distribute food to participants through
      local retail outlets, and most agencies implemented cost containment by
      obtaining contracts from formula manufacturers for cash rebates on
      infant formula. Although several types of rebates were developed, we
      focused our review on competitive sole source and open market rebate
      contracts since they are the most commonly used approaches to cost
      conta.inment.2

      In discussions with your staff, we agreed to provide information on
      (1) the status of WIGagencies’ implementation of infant formula cost-
      containment initiatives, (2) the effect of cost-containment initiatives on
      the cost of infant formula to the WIGprogram, and (3) the structure of
      the infant formula industry and its effect on cost-containment
      initiatives.

      To obtain this information, we did the following: surveyed all 86 WC
      agency directors using a mail questionnaire; conducted field work at
      seven WIGstate agencies; interviewed officials of the Food and Nutrition

       ‘In a 1987 report                        Food Program: Using Cost Savings Methods Could Increase
      Partici ation (GAO/RC                   Ott 9 1987), GAO estimated that a significant number of
      iiGi&m-     ants, or children could be hd& k the WIG program by applying savings acheved IITthe
      purchase of infant formula at less than retail cost.

      2Under the competitive sole source approach, a contract is awarded to the manufacturer who submts
      the best bid (that is, either the lowest net cost of infant formula or the highest rebate). Under the
      noncompetitive open market approach, WIG agencies award contracts to all manufacturers that agree
      to provide rebates to the WIG program. However, manufacturers that do not offer rebates can con-
      tinue to sell their products through the WIG program.



      Page 1                                      GAO/HRD-Wl22        Infant Formula in the H’lC Prograxn
                   B-240766




                   Service (FNS),which administers the program for the U.S. Department of
                   Agriculture; interviewed three infant formula manufacturers, including
                   two of the three largest domestic infant formula producers; and esti-
                   mated the effect of various factors on the prices WIG agencies paid for
                   infant formula. We conducted our review between April 1989 and
                   October 1989 in accordance with generally accepted government
                   auditing standards. See appendix I for a detailed description of our
                   scope and methodology.


                   Cost-containment initiatives for infant formula have been an effective
Results in Brief   means of saving WIGfood funds and increasing program participation.
                   Over fiscal years 1988 and 1989, infant formula rebates generated
                   cumulative savings of about $326 million. As a result of cost-contain-
                   ment initiatives for infant formula, the WIG program now reaches about
                   60 percent of eligible women, infants, and children.

                   Our analysis showed that WIG agencies that used competitive bidding to
                   obtain rebate contracts realized the greatest savings. At the time of our
                   review, the average price paid for a 13-ounce can of milk-based formula
                   by agencies with competitive sole source contracts was $0.36 lower than
                   the price paid by agencies with open market contracts.

                   During our review period, WIG agencies with retail food distribution sys-
                   terns could choose between various cost-containment approaches. In
                   November 1989, the Child Nutrition and WIG Reauthorization Act of
                   1989 (P.L. 101-147) was enacted. This act requires WIGagencies with
                   retail food distribution systems to use competitive bidding to procure
                   infant formula, unless another cost-containment approach yields equal
                   or greater savings.3

                   Rebate amounts have varied substantially over time and among WIG
                   agencies. Our analysis of the infant formula industry showed that the
                   introduction of competitive bidding led to greater cost-containment sav-
                   ings than those resulting from the open market approach. Recent bid-
                   ding patterns since the passage of P.L. 101-147, however, indicate that
                   formula manufacturers may be modifying their bidding strategy. Win-
                   ning bids received by several WIG agencies during 1990 have provided
                   lower rebates than the winning bids received during the time of our
                   review. On May 29,1990, the Federal Trade Commission (FTC)

                   3The Secretary of Agriculture is authorized to waive the requirement for competitive blddlng   m   the
                   procurement of infant formula for Indian agencies with 1,000 participants or less.



                   Page 2                                      GAO/llIKMN122      Infant Formula in the WIG Engram
             B-245706




             announced that it will conduct an inquiry focused on pricing patterns in
             the infant formula industry.

             Because only three firms are responsible for almost all domestic infant
             formula production, coordination of pricing and marketing strategies
             between the manufacturers is always a potential danger. Competitive
             bidding, required by P.L. 101-147, will successfully yield high rebates
             only to the extent that infant formula manufacturers act independently.
             Consequently, the FTC’S efforts to assure competition in the infant
             formula industry will be an important element in state efforts to maxi-
             mize cost-containment savings to maintain or expand WIGservice levels.



Background   or children under the age of 5 who are at nutritional risk. In fiscal year
             1989, WIGserved an estimated 4.1 million participants per month, and
             federal program costs totaled $1.90 billion. State or local matching of
             federal funds is not required, although 15 states appropriated about
             $68.5 million in state funds for WIG food purchases in fiscal year 1990.
             In-kind contributions (office space, support from accounting and payroll
             staff, and maintenance and security services) are also provided by the
             states.

             FNSadministers the program and provides grants to (1) WIGagencies in
             the 50 states, the District of Columbia, Puerto Rico, Guam, the Virgin
             Islands and (2) 32 officially recognized Indian agencies. WIGgrants are
             used to provide supplemental food to each WIG participant and to pay
             W’IC agency administrative costs. Each WIGagency determines the income
             eligibility of its participants. Most agencies use the maximum limit of
              185 percent of the federal poverty level. established by the U.S. Depart-
             ment of Health and Human Services. WIGagencies also give priority to
             different categories of participants, according to nutritional and health
             risk criteria. Pregnant and breast-feeding women and infants with docu-
             mented nutritionally related medical problems are given the highest pri-
             ority. The other WIGparticipant categories are postpartum women and
              children.

              WIG agencies provide participants with specific food packages depending
              on their nutritional needs. Agencies distribute these packages through
              one or more systems: retail purchase, under which participants use
              vouchers or checks issued by WIGstaff to buy authorized foods at retail
              stores; home delivery, under which food is delivered directly to the
              homes of participants by companies under contract with the state or


              Page 3                          GAO/IiRD9@122 Lnfant Fomwla in the HI{. Pro(pam
                            local WIGagency; and direct distribution, under which participants pick
                            up food (purchased in bulk by the WIG program) at designated distribu-
                            tion points. The retail purchase system is the most commonly used food
                            distribution system.


Infant Formula Targeted     WIGdirectors targeted infant formula as a source of food cost reductions
                            for three reasons. First, infant formula accounted for nearly 40 percent
for Cost-Containment        of total WIGfood costs. Second, formula prices rose at a faster rate than
Efforts                     overall food prices -the price of infant formula doubled during the
                            1980s. Third, the structure of the infant formula industry suggested
                            that cost-containment initiatives could be successful.


Rebate Approach to cost     Several strategies evolved for reducing the cost of infant formula,
                            depending on the type of food distribution system used. WIGagencies
Containment                 with home delivery and direct distribution systems first tried infant
                            formula cost containment in 1974. These agencies solicited competitive
                            bids and selected the lowest bidder as their infant formula supplier. In
                            the mid-1980s, WIGagencies with retail distribution systems developed
                            strategies to obtain infant formula rebates; through these rebates, man-
                            ufacturers reimburse the WK program a set contract amount for each
                            unit of formula WIGparticipants purchase from retail stores. Two main
                            rebate approaches evolved:

                          . Competitive sole source. Under this approach, a wxc agency awards a
                            contract to the manufacturer who submits the best bid, usually defined
                            as either the lowest net cost of infant formula or the highest rebate. WIG
                            participants can purchase only the formula manufactured by the com-
                            pany providing the rebate, unless a physician prescribes an alternative
                            brand for medical reasons. The winning infant formula manufacturer
                            receives the distinction and market advantage of being the only infant
                            formula provider for a state’s WIGprogram.
                          . Open market. Under this noncompetitive approach, a WIG agency may
                            award contracts to more than one manufacturer that agrees to provide a
                            rebate. Companies that do not offer rebates can continue to sell their
                            products through the WIGprogram. Participants are not restricted tn
                            their choice of formula, and WIGstaff cannot encourage the use of
                            formula brands for which rebates are provided over other brands f hat
                            do not provide rebates. The formula manufacturers that provide rebates
                            protect current market positions, but receive no additional benefit




                            Page 4                           GAO/EfRDBW22 Infant Formula in the W(’ f’m@nm
                        B-240766




                        At the time of our review, 61 of the 86 WIGagencies had contracts to
Most WIC Agencies       obtain formula at a cost savings. Fifty-seven WIGagencies implemented
Had Cost-Containment    retail rebate contracts; 5 had home delivery contracts, and 3 had direct
Contracts               distribution contracts4 Of the 57 agencies with retail rebate contracts,
                        35 used the open market rebate approach; 18 used the sole source rebate
                        approach; 3 used the competitive multi-source rebate approach; and 1
                        used the preferred provider rebate approach. However, the 18 agencies
                        that used sole source rebates served 57 percent of the WIGinfant popula-
                        tion Almost all agencies awarded their rebate contracts to one or both
                        of the largest domestic infant formula manufacturers-Ross       Laborato-
                        ries and Mead Johnson. (See app. II, p. 12, for details on the status of
                        cost-containment initiatives.)


                        Over fiscal years 1988 and 1989, infant formula rebates generated
Cost-Containment        cumulative savings of about $326 million. These savings were used to
Savings Have Resulted   increase total program participation from less than 50 percent of eligible
in Program Expansion    women, infants, and children to about 60 percent of those eligible for the
                        program. Rebate savings supported an estimated 74,000 women, infants,
                        and children per month in fiscal year 1988 and an additional 400,000
                        WIGparticipants per month in 1989. (See app. II, p. 18.)


                        Our analysis shows that at the time of our review, several factors influ-
Competition Produced    enced the cost of infant formula to WIG agencies. WIG agencies that paid a
Lowest Infant           lower price for infant formula (1) used competitive bidding to obtam
Formula Prices          rebate contracts, (2) served a low percentage of their eligible population,
                        or (3) were state agencies rather than Indian agencies.

                        Competitive bidding had the greatest effect on reducing the after-rebate
                        price of infant formula sold to WIGagencies. The average price pard for a
                        13-ounce can of milk-based formula concentrate by agencies with com-
                        petitive sole source contracts was $0.36 lower than the average pnce
                        paid by agencies with open market contracts. The after-rebate price
                        paid by WIGagencies for a 13-ounce can of formula ranged from SO.13 to
                        $1.24. (See apps. II, p. 18, and III, p. 28.)




                        4The total number of cost+xMtaiNnent contracts is greater than 61 because some WlC &W N- had
                        more than one type of distribution system and awarded more than 1 co&containment $1tncrb T



                        Page 6                                   GAO/HRIM@l22      Infant Formula in tbr wl( hogram
                       Rebate amounts have varied substantially over time and among WIG
Amount of Rebates      agencies. Until recently, the size of rebates increased steadily as the
Varied Substantially   three major manufacturers sought to capture or maintain market shares.
Over Time              Tennessee accepted the first bid ($0.40) submitted under the competi-
                       tive sole source approach in August 1986. The rebate amounts under the
                       competitive approach reached their maximum of $1.52 in October 1989.
                       The first open market bids ranged from $0.17 to $0.23, and the average
                       open market rebate was about $0.95 by the end of 1989.

                       Since February 1990, however, rebate bids have been lower. Kine states
                       opened bids for rebates between February and May 1990. During this
                       period, the maximum bid under the competitive approach fell to $1.30
                       and most of the competitive bids were for about $0.75 or less. Testimony
                       on May 29, 1990, before the Subcommittee on Antitrust, Monopolies and
                       Business Rights, Senate Judiciary Committee, revealed that one manu-
                       facturer notified four WE agencies, in a March 1990 letter, that it
                       planned to submit rebate bids of $0.75 under both competitive and open
                       market approaches. Further testimony indicated that other infant
                       formula manufacturers also appeared to be lowering their bids to about
                       the $0.75 level for rebate contracts. (See app. II, p. 20.) Concerns about
                       the above industry actions prompted the FTCto initiate an inquiry on
                       pricing patterns in the infant formula industry.

                       Our analysis of the domestic infant formula industry indicates that the
                       introduction of competitive bidding led to greater cost-containment sav-
                       ings than those resulting from the open market approach because the
                       industry lacks strong inherent pressure for price competition. In the
                       absence of competitively bid contracts, the natural pressures for price
                       competition between manufacturers are limited for the following rea-
                       sons: (1) there are few competitors in the domestic infant formula
                       market; (2) it is difficult for new competitors to enter the domestic
                       market; and (3) consumer selection of formula brands may be relatively
                       unresponsive to price differentials between brands. (See app. II, p. 2 1.)

                       Recent bidding patterns by the three major manufacturers do not pro-
                       vide a clear indication of the future direction of rebates. However, if
                       average rebate amounts decline without a commensurate increase in
                       appropriations, fewer women, infants, and children will be served by
                       the WIGprogram. Competitive bidding, required by P.L. 101-147, will
                       successfully yield high rebates only to the extent that infant formula
                       manufacturers act independently. Efforts by the FIY:to assure competi-
                       tion in the infant formula industry will be an important element in state



                       Page 6                          GAO/EED~l22    Infant Formula in the WIG Program
                  B240766




                  efforts to maximize cost-containment savings to maintain or expand WK
                  service levels.


                  We did not obtain written agency comments, but discussed the contents
Agency Comments   of this report with FNSofficials and incorporated their comments in the
                  report as appropriate.


                  We are sending copies of this report to the Secretary of Agriculture; the
                  Director, Office of Management and Budget; and to interested congres-
                  sional committees and members. We wiII make copies available to others
                  on request.

                  If you or your staff have any questions about this report, please call me
                  on (202) 275-1656. Other major contributors to this report are listed in
                  appendix IV.

                  Sincerely yours,




                  Linda G. Morra
                  Director, Intergovernmental
                     and Management Issues




                   Page 7                          GA0/IluDm1za   hfhnt PormEla In the WK PmF=
Contents


Letter
Appendix I
Scopeand
Methodology
Appendix II                                                                                               12
Most WIC Agencies        Cost-Containment Savings Have Resulted in Program
                              Expansion
                                                                                                          18
Have Implemented         Structure of the Infant Formula Industry Affects Bidding                         21
Cost-Containment              Strategy
Initiatives for Infant
Formula
Appendix III                                                                                              26
Economic                 Effect of Bidding Systems on Adjusted Price
                         Effect of Population on Adjusted Price
                                                                                                          26
                                                                                                          27
Determinants of the      Geographic Cost Differentials                                                    27
Adjusted Price for       Calculating the Average Adjusted Price                                           28
Ini&lt   Fo~ula-GAO      Regression Analysis Results                                                      28
Analysis
Appendix IV                                                                                               31
Major Contributors to
This Report
Tables                   Table II. 1: Status of Indian and Territorial WIC Agencies’                      15
                             Cost-Containment Initiatives
                         Table 11.2:WIC Agency Rebate Contract Awards to Infant                           17
                             Formula Manufacturers
                         Table 11.3:Range of Rebates and Adjusted Formula Prices                          19
                             for Retail Contracts Awarded to Three
                             Manufacturers (as of June 1,1989)
                         Table 111.1:Definition of Variables Used in Regression                           30
                             Analysis
                         Table 111.2:Regression Results                                                   30



                         Page g                          GAO/HRDBQ-122   Infant   Fomwla   in the WC Program
          Contents




Figures   Figure II. 1: Status of WE Agency Cost-Containment                            14
               Initiatives
          Figure 11.2:Agencies and WIC Infant Population Served                         16
               by Type of Rebate Contract
          Figure 11.3:WIC Infant Population Served by Contracts                         17
               Awarded to Manufacturers




          Abbreviations

          Fw3        Food and Nutrition Service
          FTC        Federal Trade Commission
          RiT        request for proposal
          WIG        Special Supplemental Food Program for Women, Infants. and
                        Children


          P4W9                           GAO/LIBDgol22   Infant Formula in the WIG f’rogram
Appendix I

Scopeand Methodology


             Using a mail questionnaire, we surveyed all WIGagency directors for
             information concerning their efforts to implement cost containment for
             infant formula. Questions focused primarily on WIGparticipant informa-
             tion, cost-containment contracts, program administration, and opinions
             on various cost-containment issues. Before we mailed the questionnaire
             to respondents, we discussed it with FNSofficials and pretested it with
             WIGdirectors in four state agencies and one Indian agency.

             Our survey universe consisted of 87 WIGagencies in the 50 states, the
             District of Columbia, three territories, and 33 officially recognized
             Indian tribes or councils.* Copies of the questionnaire were mailed in
             July 1989, and 76 responses were received by September 22, 1989. We
             telephoned all WIGprogram directors who had not responded and
             recorded their responses. After adjusting the universe to 86, because of
             the Indian agency that was no longer operating a WIGprogram, the
             response rate was 100 percent.

             To obtain more detailed information, in August and September 1989 we
             did field work at the WIGagencies in Alabama, Arkansas, Delaware, the
             District of Columbia, Florida, Oregon, and Wisconsin. The field work
             locations were selected based on the type of rebate contract (open
             market or sole source) and diversity of geographic representation. We
             selected only agencies with rebate contracts since that was the most
             commonly used co&containment approach.

             To obtain background information and documentation on WIGlegislation,
             regulations, and program operations, we met with officials at FNShead-
             quarters and one regional office. We also met with three infant formula
             manufacturers-Ross     Laboratories, Wyeth-Ayerst Laboratories, and
             Carnation-to   obtain their views on the infant formula industry and
             costcontainment initiatives.*

             To study the effects of different initiatives on the cost of infant formula,
             we reviewed differences in the adjusted price (wholesale list price minus
             rebate) of 13-ounce cans of concentrated milk-based formula. To distin-
             guish the separate effects that selected factors (such as bidding system
             employed, size of the WIGand non-wIc infant population, and regional
             cost differentials) had on the adjusted price of infant formula, we

             ‘During our rwiew, one Indian agency discontinued its WIG program.

             %‘e requested a meeting with representatives of Mead Johnson and provided them with a 1st of
             que&bns to obtain their views on infant formula cost containment. After several attempts. we were
             unable to schedule a meeting with Mead Johnson representatives.



             P8ge 10                                    GAO/ERM@122        Infant Formuln in the WIC pro(pam
Appendix I
Scope and Methodology




employed multiple regression analysis- a standard statistical technique
that quantifies the relationship between a dependent variable and a set
of independent variables. We limited our analysis to the 42 state agen-
cies and 14 Indian agencies that used retail rebate contracts and pro-
vided sufficient data.3 The specific variables employed in the analysis
and the regression results (estimated coefficients and their standard
errors) are reported in appendix III, page 30.

Our audit work was carried out between April 1989 and October 1989 in
accordance with generally accepted government auditing standards.




 30ne WIG agency with an open market contract did not provide complete information     and WLS not.
 therefore, included in the regression analysis.



 Page 11                                       GAO/HEDgOl22     Infant   Formula   in the WC Rogrm
Appendix II

Most WIC AgenciesHave ImplementedCost-
Containment Initiatives for Infant Formula

                        At the time of our review, 61 of the 86 wrc agencies (71 percent) had
                        contracts with infant formula manufacturers to obtain formula at cost
                        savings. Retail rebate contracts were the cost-containment approach
                        most frequently used. Of the 86, 57 implemented retail rebate contracts;
                        5 had home delivery contracts, and 3 had direct distribution contracts.1
                        Of the 57 agencies with rebate contracts, 35 used the open market
                        approach; 18 used the sole source approach; 3 used the multi-source
                        approach, and 1 used the preferred provider approach.” The 18 agencies
                        with sole source contracts, however, served 57 percent of the total WIG
                        infant population. Two manufacturers-Ross       Laboratories and lMead
                        Johnson-were      awarded almost all of the rebate contracts.


Most’WIC Agencies Had   Of the 86 WIGagencies, 61 -45 state agencies and 16 Indian agencies-
                        had contracts to obtain formula at cost savings; 25 WIGagencies-6 state
Cost-Containment        agencies, 16 Indian agencies, and 3 agencies in the U.S. territories-did
Contracts for Infan t   not have cost-containment contracts at the time of our review.
Formula
                        Although these 25 agencies did not have cost-containment contracts, 17
                        directors indicated that they planned to award contracts within 9
                        months; 13 of these directors reported that they planned to award open
                        market rebate contracts.3 The remaining 8 agencies-all Indian agen-
                        cies-served a small number of participants, but a high percentage of
                        the eligible population; therefore, the directors of these agencies said
                        they either (1) would not award a cost-containment contract or (2) were
                        not sure when they would award a contract.

                        Of the 57 WIGagencies with rebate contracts, 35-15 Indian agencies
                        and 20 state agencies- had open market rebate contracts with two or
                        more infant formula manufacturers; 18 state agencies had sole source
                        rebate contracts, including three WC agencies-Maryland,    Delaware,
                        and the District of Columbia-that   jointly awarded a rebate contract
                        covering the three WIGprograms. Three WIGagencies received rebates
                        through multi-source contracts, and one agency awarded a preferred

                        ‘The total number of cost-containment contract8 is greater than 61 because some WIC agencies had
                        more than one type of distribution system and awarded more than 1 cost-containment contract.

                        ‘Under the multi-source rebate approach, contracts are awarded to the best bidder and to any other
                        bidders who meet specified minimum bid criteria The preferred provider approach was ongu~Ily
                        intended to be a modification of the open market approach. However, after further consultation wxh
                        FNS, the state agrees that this is a form of competitive bidding.

                        3The directors’ comments about their cost-containment plans were made before P.L. 101- 117 was
                        passed, it requires WIG agencies with retail distribution systems to use competitive sole source
                        contracts.



                        Page 12                                     GAO/HRCg@l22       Infant   Formula   in the WIG Rorpam
Appendix II
Moot WIC Agencies Have Implemented Co&-
Containment initiativea for Infant Formuh




provider rebate contract. The type of cost-containment initiative used
by the 50 state agencies and the District of Columbia is shown in figure
11.1.




 Page 13                                GAO,‘HRD-g@l22   Infant   Formula   in the %‘-IC f+‘+P--
                                            Appendix Jl
                                            Meet WIG Agencies Rave Implemented Co&-
                                            Containment Initiatives for Infant Formula




Figure 11.1:Status of WIC Agency Cost-Containment initiatives




                                                  solesourc%contraaa

                                                  open     Market      conoact        b

                                                  Nocontrw

                                                  Mrect Dlatrlbution             corlbga

                                                  time Dalivery Contract c


                                            %olorado. Kansas, and PennsylvanIa used multi-source rebate contracts, which are a ~arla!a ;f the
                                            sole source rebate approach.
                                            blllinols used a preferred provider contract.
                                            %aryland, New Hampshire, and Vermont also used home delivery contracts to serve a MOTTO-:+ *hell
                                            WC partlclpants.

                                            The status of cost-containment efforts in the 32 Indian agencies and the
                                            U.S. territories is shown in table 11.1.


                                             Page 14                                       GAO/liRDWl22   infant   Formula   In the ml,lc f’rogram
                                              Most WlC Agencies Have Implemented Coet-
                                              Containment    Initiatives   for infant     Formula




Table 11.1:Status of Indian and Territorial
WIC Agencier’ Cost-Containment                Indian WIC agencies
initiative8                                   Open market                               Manlllaq Assoclatbon, AK
                                                                                        lntertnbal Council of AZ
                                                                                        Ute Mountain Tribe, CO
                                                                                        NE lndlan intertribal Development Corporation
                                                                                        Ftve Sandoval Indian Pueblos, NM
                                                                                        Seneca Nation, NY’
                                                                                        Three Affiliated Tribes, ND
                                                                                        Chicksaw Nation, OK
                                                                                        Intertribal Council of OK
                                                                                        Cherokee Nation, OK
                                                                                        Tonkawa, OK
                                                                                        Choctaw Nation of OK
                                                                                        Cheyenne River Sioux Tribe, SD
                                                                                        Rosebud Sioux Tribe. SD
                                                                                        Shoshone and Arapahoe, WY
                                              Home delivery                             Seneca Nation, NYa
                                              Direct distribution                       San Felipe, NM
                                              No contract                               Navajo Nation, AZ
                                                                                        Miccosukee Indians, FL
                                                                                        Seminole, FL
                                                                                         Indian Township, ME
                                                                                         Pleasant Point, ME
                                                                                         Choctaw Indians of MS
                                                                                         Intertribal Council of NV
                                                                                         San Domingo, NM
                                                                                         ACL. NM
                                                                                         Pueblo of Zuni, NM
                                                                                         Eight Northern Indian Pueblo Council of NM
                                                                                         Pueblo of Isleta, NM
                                                                                         Eastern Band of Cherokee Indians, NC
                                                                                         Standing Rock Sioux Tribe
                                                                                         Potawatomi Indians of OK
                                                                                         WCD Enterpnses, Inc.
                                              U.S. WIC territories                                                                            -   .-
                                              No contract                               Guam
                                                                                        Puerto Rico
                                                                                        Virain Islands
                                              aWIC agency had contracts for more than one type of distribution system.
                                              Source: The data in this table are based on responses to the GAO questionnaire sent 10 lnduF agencces
                                              and WlC agencies in the U.S. terntories.




                                              Page 16                                               GAO/HED9@122   Infant   Formula   in tie ww‘ Program
                                      Appendix II
                                      Meet WIG Agencies Have Implemented Cost-
                                      Containment Initiativea for Infant Formula




Most WIC Infants Served               More WIG agencies had open market rebate contracts, but, as shown in
by Sole Source Contracts              figure 11.2,a larger portion of the WIG infant population was sewed by
                                      the agencies with competitive sole source contracts.


Figure 11.2:Agencies and WIC Infant
Population Served by Type of Rebate   loo    Percml
Contract
                                       90



                                       70

                                       60
                                       so
                                       40
                                       30
                                       20
                                       10

                                        0
                                            ~~




                                                      Agmcles Using Contract Type
                                                      WC Infants ssrved

                                      Source: Responses to the GAO questionnaire    and USDA data on the WIC infant population




Most Rebate Contracts                 Almost all of the WIGagencies with rebate contracts awarded their con-
Awarded to Two                        tracts to two manufacturers, Ross Laboratories and Mead Johnson. The
                                      distribution of rebate contracts among infant formula manufacturers at
Manufacturers
                                      the time of our review is shown in table 11.2.




                                      Page 10                                       GAO/liRDBS122     infant   Formula   in the WIG Program
--
                                           Appendix II
                                           Moot WIG Agencies Have Implemented Cost-
                                           Containment Initiatives for Infant Formula




Table 11.2:WIC Agency Rebate Contract                                                     . -
Awards to Infant Formula Manufacturers                                                  WIC agencies awarding contracts
                                                                                     Open
                                                                                    market Sole source         Other                           Total
                                           Mead Johnson                                  33                9                     3               45
                                                                                                                                     ___~--_
                                           Ross                                          31                7                     4               42
                                           Wyeth-Ayerst                                    3                2                    0                 5
                                           Loma Linda                                      1               0                     0                 1
                                           CarnatIon                                       1               0                     0                 1

                                           Source These data are based on responses to the GAO questjonnalre      by WIG directors


                                           The contracts awarded to Ross represented a larger share of the WIG
                                           infant population than did the contracts awarded to Mead Johnson,
                                           although more WIGagencies awarded contracts to Mead Johnson (see fig.
                                           11.3).


Figure 11.3:WIC Infant Population Served
by Contracts Awarded to Manufacturers




                                                                                                ROSS




                                                                                                Mead Johnson

                                           Note: Other manufacturers serve less than 1 percent of the WIC infant population.
                                           Source: Responses to the GAO questlonnalre and USDA data on the WIC infant populatbon




                                           P8ge 17                                    GAO/HRBBM2!2       Infant     Formula   in the WC Program
                            Appendix II
                            Meet WC Agenclea Have Implemented Cost-
                            Containment Initiatives for Infant Formula




&Win@
                            Cost containment for infant formula has been an effective means of
Cost-Containment            saving WIGfunds and increasing program participation. FNSestimates
        Have Resulted       that infant formula rebates generated cumulative savings of about
in Program Expansion        $326 million over fiscal years 1988 and 1989. These savings were used
                            to increase total participation to about 60 percent of those eligible for
                            the program. Approximately 474,000 WE participants were supported
                            by rebate savings through the end of fiscal year 1989.

                            As shown in our regression analysis, competitive bidding was the
                            greatest determinant of a lower adjusted price for infant formula. WIG
                            agencies using the competitive sole source approach received higher
                            rebates and paid a lower adjusted price for infant formula.


Rebate Savings Result in    Of the 57 WIGagencies we surveyed with retail rebate contracts, 32 had
                            received a total of $167 million in rebates from the effective dates of
Program Expansion           their current contracts through May 1, 1989.4 F’NSestimates that infant
                            formula rebates generated $32.6 million in savings and supported
                            approximately 74,000 participants per month in fiscal year 1988. For
                            fiscal year 1989, FNSreported rebate savings of $293 million, which sup-
                            ported an additional 400,000 program participants per month. Savings
                            estimates were not available for cost-containment initiatives using home
                            delivery or direct distribution approaches.


Three Factors Resulted in   Our regression analysis of rebates identified three factors that were sta-
                            tistically significant determinants of a lower adjusted price (wholesale
Lower Formul .aPrices for   list price minus rebate) for infant formula in the WIGprogramj Holding
WIC Agencies                all other factors constant, we found that WIGagencies paid less for milk-
                            based infant formula if they (1) used competitive bidding to obtain a
                            rebate contract, (2) served a low percentage of their eligible WIGpopula-
                            tion, or (3) were state agencies rather than Indian agencies. We found no
                            evidence that the total number of infants served by a WIGagency
                            affected the price paid for infant formula: that is, it did not appear that
                            agencies with large WIGpopulations obtained higher rebates than agen-
                            cies with small WIGpopulations.

                            Of the factors considered in our economic analysis, competitive bidding
                            (sole source and multi-source) had the greatest effect on reducing the

                            40ne WIG agency with a rebate contract did not provide information on the amount of rebate2 IChad
                            received. Contracts for the remaining 24 agencies were not effective until after May 1, 1989
                            5Seeappendix Ill for a discussion of statistical significance and the criteria used for tha analysa



                            Page 18                                      GAO/HEBB@122 Infant Formula Ln the WC Program
                                     Appendix II
                                     Moot WIG Agenciee Have Implemented Cost-
                                     Containment Initiatives for Infant Formula




                                     price of infant formula. WIGagencies that solicited bids using the com-
                                     petitive sole source approach received higher rebates and paid an
                                     average adjusted price that was $0.36 lower than the average adjusted
                                     price paid by agencies using the open market approach. Under the com-
                                     petitive multi-source approach, adjusted prices were $0.24 lower than
                                     open market prices.

                                     As shown in table 11.3,as of June 1, 1989, the lowest sole source rebate
                                     for a 13-ounce can of concentrated milk-based formula was $1.05, which
                                     was $0.04 higher than the highest open market rebate of $1 .Ol. The
                                     aausted price of formula varied by as much as $1.11, ranging from
                                     $0.13 to $1.24.

Table 11.3:Range of Rebates and
Adjusted Formula Prices for Retail                                                            Infant formula manufacturers
Contracts Awarded to Three                                                                                     Mead
Manufacturers (asof June 1, 1989)    Formula price                                             ROM          Johnson                         Wyeth
                                     Wholesale     price                                           $1.58                     $1 55              $1 45
                                     Open market
                                     Rebate     rafwe                                     0.47-l      01            0.47-O      97      021-088
                                     Adjusted     price range                             1 11-0.57                 1.08-0.58           1 24-O      57
                                     Sole source
                                     Rebate ranae                                         1.05-l .45                1.09-l      36      109-t       13
                                     Adjusted     price range                             0.53-0.13                 0.46-O      19      0 36-0.32
                                     Multi-source
                                     Rebate range                                         101-1.21                            0 97
                                     Adiusted     txice    ranae                          0.57-0.37                           0.58

                                     Note: Rebate amounts, adjusted prices, and wholesale prices are for a 13.ounce can of concentrated
                                     milk-based formula. Adjusted price is determined by subtracting the rebate from the manufacturer s
                                     wholesale price.


                                     WIGagencies that served a low percentage of their eligible population
                                     paid less for infant formula than agencies that served a high percentage
                                     of their eligible population. An increase of 10 percentage points in the
                                     proportion of the eligible population served was associated with an
                                     adjusted price that was $0.04 higher. This could occur because manufac-
                                     turers may be reluctant to offer high rebates when savings unused by a
                                     WIGagency are returned to FNSand distributed to other agencies that
                                     may be served by competing manufacturers.

                                     On average, Indian agencies that have retail rebate contracts paid $0.55
                                     more for infant formula than WIG agencies administered by states with
                                     retail rebate contracts. The regression results indicate that part of the



                                     Page 19                                      GAO/HRD9@122             Infant   Formula     in the WIG Program
                                                                                                                              -
                          Appendix II
                          Most WlC Agencies Have Implemented Cht-
                          Containment Initiatives for Infant Formula




                          difference ($0.17) occurs because all of the Indian agencies have open
                          market contracts, and 50 percent of the states have competitively bid
                          contracts. The fact that Indian agencies serve a higher proportion of
                          their eligible population, on average, than state agencies explains an
                          additional $0.11 of the difference.” The remainder ($0.27) of the differ-
                          ence between the price paid by Indian agencies and the price paid by
                          state agencies cannot be explained by the factors we considered in our
                          economic analysis.

                          Program regulations do not prohibit Indian agencies from obtaining
                          infant formula at lower prices in conjunction with state agency cost-con-
                          tainment contracts. On average, Indian agencies served a higher per-
                          centage of their eligible population due, in part, to their close working
                          relationship with Indian health agencies. The high service levels realized
                          by many Indian agencies reduce their incentive for saving on formula
                          costs because the opportunities for expanding their own programs are
                          limited. However, such savings could be redistributed to other WIGagen-
                          cies with greater potential to increase their service levels.


Amount of RebatesVaried   The amount manufacturers bid for rebate contracts has varied substan-
                          tially over time and among the states. In August 1986, only one manu-
Widely Over Time          facturer responded to Tennessee’s second request for proposal (RFP) for
                          competitive bids to become the sole supplier of WIGinfant formula in the
                          state. No manufacturers had responded to the state’s first RFP in Jan-
                          uary 1986. Tennessee accepted the manufacturer’s rebate offer of $0.40
                          per can. Oregon accepted a competitively bid rebate offer of $0.60 from
                          the same manufacturer in July 1987. Again, this manufacturer was the
                          only company to bid on Oregon’s competitive RFP.

                          Various states proceeded with either open market or competitive sole
                          source approaches for containing infant formula costs. The open market
                          approach was adopted by Florida, Michigan, and Wyoming in late 1987
                          and early 1988. Winning bids ranged from $0.17 to $0.23. In March
                          1988, Texas elected the competitive sole source approach and accepted a
                          winning bid of $0.92. This was a significant bid because it was the first
                          time that more than one major manufacturer had bid under the competi-
                          tive approach to cost containment.



                          ‘%I average, Indian agencies served 72.6 percent of their eligible population; non-Indian agencws
                          served 47.8 percent.



                          Page 20                                     GAO/HRDSlkl22      infant   Formula   in the WIG Program
--
                              Appendix II
                              Moat WIG Agencies Have Implemented Coet-
                              Containment Initiatives for Infant Formula




                              Two or more of the major manufacturers submitted competitive or open
                              market bids in response to all but one of the state agency bid requests
                              issued during the remainder of 1988 and in 1989. Although the two
                              largest manufacturers urged states to reject competitive bidding and to
                              adopt the open market approach, the manufacturers generally
                              attempted to win sole source contracts by submitting competitive bids.
                              By the end of 1989, 19 states had competitive sole source contracts and
                              the average rebate level in these states was $1.37 per can. Rebate levels
                              for open market contracts rose as well. By the end of 1989, the average
                              rebate level for the open market approach was about $0.95 per can.;

                              In March 1990, the trend of the earlier 2 years was upset when one man-
                              ufacturer notified several states in writing that it planned to submit bids
                              of $0.75 under both competitive and open market approaches. Other
                              infant formula manufacturers have modified their bidding strategies,
                              resulting in lower winning bids for rebate contracts in 1990.


                              The introduction of competition led to greater cost-containment savings
Structure of the Infant       than those resulting from the open market approach because of (1) the
Formula Industry              structure of the infant formula industry and (2) the environment in
Affects Bidding               which it operates. In the absence of competitively bid contracts, the nat-
                              ural pressures for price competition between manufacturers in the
Strategy                      infant formula industry are limited for several reasons:

                          . There are few competitors, with three manufacturers producing almost
                            all of the domestic output of infant formula.
                          . It is difficult for new competitors to enter the domestic market.
                          l Consumer selection of formula brands may be relatively unresponsive to
                            price differentials between brands.


Three Manufacturers           The domestic infant formula industry, with sales in the United States of
                              over $1.4 billion in 1987, is one of the most concentrated manufacturing
Produce Almost All            industries in the country. There have been three major producers since
Domestic Infant Formula       the 197Os, all owned by pharmaceutical companies. Ross Laboratories,
                              owned by Abbott Laboratories, produces Sirnilac brand infant formula;
                              Mead Johnson, owned by Bristol-Myers, produces Enfamil; and Wyeth-



                               ‘Testimony of Stefan Harvey, Director, Supplemental Food Program      Project, Center on Budget and
                               Policy Priorities, before the SubcommitWe on Antitrust, Monopolies,   and Business Rights Snare
                               Judiciary Committee (May 29,lQQO).



                               P8ge 21                                     G~O/IilUS9&122      Infant   Formula   in the WC Pro-
                          Appendix II
                          Most WIG Agencies Have Implemented Cost-
                          Containment Initiativea for Infant Formula




                          Ayerst Laboratories, owned by American Home Products, produces SMA
                          brand.

                          The three largest manufacturers produced approximately 99 percent of
                          all domestic infant formula in 1987. Estimates of the individual market
                          shares of these manufacturers are Ross, 55 percent; Mead Johnson, 35
                          percent; and Wyeth-Ayerst, 9 percent. These market shares show that
                          the infant formula industry in the United States is highly concentrated.
                          Loma Linda, Nestle’s S.A. Carnation, and Gerber also sell infant formula
                          in the United States; they jointly accounted for less than 1 percent of the
                          domestic market.

                          Even though consumers may exhibit brand preferences, infant formula
                          is a relatively homogeneous product. Since the passage and implementa-
                          tion of the Infant Formula Act of 1980, all brands of milk-based formula
                          are nutritionally identical. The Infant Formula Act specifies nutrient
                          content based on recommendations of the Committee on Nutrition of the
                          American Academy of Pediatricians. In addition, the Secretary of Health
                          and Human Services establishes requirements for nutrient quality fac-
                          tors and quality control procedures. Some infants can develop allergies
                          to specific brands of formula, however, because of differences in nonnu-
                          tritional content.

                          One factor that provides some differentiation between products in this
                          industry is the existence of soy-based and whey-based infant formulas,
                          which are used to feed infants with an intolerance to cows’ milk. The
                          three major manufacturers produce both milk-based and soy-based
                          formula. Loma Linda produces only soy-based formula; Nestle’s S.A.
                          Carnation company has recently entered the market with a whey-based
                          specialty formula.


New Competitors Have      Barriers exist in the infant formula industry that inhibit the entry of
                          new firms and thus limit the degree of competition in the industry.
Difficulty Entering the   These barriers are related to marketing, rather than manufacturing, of
Market                    infant formula.8




                          ‘Manufacturing economies of scale do not appear to be substantial in the produalon of tnfant
                          formula The absolute size of the firm may affect its ability, however, to advertise and Lnfluence
                          physicians’ recommendations.



                          Page 22                                     GAO/HBD~122         Infant   Formula   in the WC Program
Appendix II
Most WIG Agencies Have Implemented Coat-
Containment InMaUves for Infant Formula




One important barrier to entry is medical detailing, which is a manufac-
turer’s practice of directly contacting hospitals and medical practi-
tioners, giving infant formula samples and other types of support, and
encouraging physicians to recommend one particular brand of formu1a.O
Medical detailing is the marketing approach used by the three major
infant formula manufacturers, which are owned by pharmaceutical
companies. Several manufacturers mentioned the marketing importance
of “discharge packs” -kits containing formula samples, cents-off cou-
pons, company advertising, and, sometimes, toys or pacifiers. Hospitals,
provided with free discharge packs from the manufacturers, give them
to mothers when they leave the hospital with their babies. This action
serves as an implicit endorsement of a particular brand of formula by
the hospital; it makes the entry of new brands that are unfamiliar to the
mother more difficult. Medical detailing may limit the ability of
nonpharmaceutical companies to compete in the domestic infant
formula industry.

Grocery shelf visibility is another important determinant of demand for
a particular fii’s product. A brand’s shelf space, however, is deter-
mined by its market share. This cycle suggests that new entrants, with
low or nonexistent market shares, will find it difficult to acquire the
shelf space necessary to make consumers aware of their products. The
use of competitive bidding by WIGagencies can help new or small firms
gain market exposure. In areas where the retail distribution system is
used, stores devote a relatively high proportion of their shelf space to
the WIGcontract brand. This increases the brand’s visibility and, in turn,
increases sales of the WC contract brand to non-wrc participants.

Finally, the manner in which some WIGcontracts are specified limits
competition. Contracts generally require that manufacturers supply
both milk-based and soy-based products. Companies that make only one
or the other, like Loma Linda or Carnation, are effectively shut out of
the bidding process.




gMedical detailing includes activities such as providing free or discounted formula and dlxharw
packs to hospitals; donating equipment and services to hospitals (for example, isolettes. mcubarors.
nursep9, volumetric tube feeders, calendars, pens, note pads, architectural planning, and pnnt11%    wr-
vices): providing free samples to physicians; and providing funding for research on mfant nutmwn to
hospitals and physicians



Page 23                                      GAO/HItD~l22        Infant Formula    in the HI<‘ Fwgram
                                Appendix II
                                Moat WIG Agencies Have Implemented C&t-
                                Containment Lnitiatlves for Infant Formula




Little Pressure for Price       The wholesale price of infant formula increased rapidly in the 1980s.
                                The weighted average price of infant formula produced by the three
Competition Between             major manufacturers increased roughly 9.5 percent annually from 1979
Manufacturers                   to 1988. To put this increase in perspective, we calculated the average
                                annual price for both the fresh whole milk industry and prescription
                                drugs. During the same period, the average annual price increase of 9.5
                                percent for infant formula was substantially higher than the average
                                annual increase in the consumer price index for fresh whole milk
                                (approximately 2 percent) and almost as high as for prescription drugs
                                (approximately 9.6 percent).

                                Manufacturers may feel little pressure to keep the price of infant
                                formula low because many consumers (1) do not pay for the formula
                                themselves or (2) consider other factors in addition to price when
                                making a brand choice. About one-third of all infant formula produced
                                in the United States is consumed by WIGparticipants. In areas with open
                                market contracts, WIG mothers can obtain any wIc-approved brand of
                                formula with their vouchers. Thus, price is not a consideration for a siz-
                                able minority of infant formula consumers. Even for non-wlc mothers,
                                price may be only one factor, along with others-such as advice from
                                physicians and brand familiarity-that    are considered in making a
                                brand choice.


Formula Manufactu rer           Prior to the passage of P.L. 101-147, representatives from one manufac-
                                turer told us that rebate amounts could be “about as high as they are
Views on Cost                   going.” The representatives added that to stay competitive in the infant
Containment                     formula market, manufacturers must be active participants in cost-con-
                                tainment initiatives. When asked why manufacturers continue to bid on
                                WIGcost-containment contracts, representatives from another manufac-
                                turer responded, “If we don’t bid, our competitors will.” Manufacturers
                                indicated that bidding on WIGcontracts represents a rational business
                                decision encouraged by competitive market forces. Of the three mqjor
                                formula manufacturers, representatives of two said that they consider
                                the following factors when bidding on WIGinfant formula contracts:

                            . impact of the results of the bid (that is, winning or losing) on the c:om-
                              pany’s market share and profitability,
                            . competitive activity in the area based on publicly available information,
                            l size of the agency’s infant WIGmarket,
                            l proximity of the company’s production facilities to the WK agem.?..
                            . production costs,
                            . available manufacturing capacity, and


                                Page 24                                  GAO/HItD9Cbl22   Infant   Formuh   in Ibr @I( t’x$ram
    Appendix II
    Moat WlC Agencies Have Implemented Cost-
    Containment Inidativee for Infant Formula




l   type of cost-containment approach being employed by the WIGagency.

    One manufacturer reported a 41 percentage point increase in its market
    share in one state after winning a competitive sole source bid. In addi-
    tion to sales generated by winning the sole source bid, representatives
    from the manufacturer stated that an increase in market share resulted
    from (1) spillover business in the non-wIc market, (2) increased business
    in hospitals within the state because of the number of WIG infants, and
    (3) improved shelf space in retail stores. This positive effect on market
    share persisted, although to a lesser extent, even after the original con-
    tract expired and a new contract was awarded to a different
    manufacturer.




     Page 26                                GA@‘?iRDBGl2!2   Infant   Formula   in the wl’1( Rrygam
Appendix III

EconomicDeterminantsof the Adjusted Price ’
for Infant Formula-GAO Analysis

                      Many factors could conceivably affect the cost of infant formula to WIG
                      agencies: the bidding system employed, size of both the WIGand the non-
                      WIGinfant populations, and any regional cost differentials. To distin-
                      guish the separate effects that each of these factors has on the price of
                      infant formula to WIG agencies, we employed multiple regression anal-
                      ysis-a standard statistical technique that quantifies the relationship
                      between a dependent variable and a set of independent variables.

                      We limited our analysis to the 42 state agencies nd 14 Indian agencies
                      that used retail rebates-the most common cost-containment
                      approach-and      provided sufficient data.’ The adjusted price is defined
                      as the wholesale list price for a 13- ounce can of milk-based formula
                      minus the rebate amount. The specific variables employed in the anal-
                      ysis are discussed below and summarized in table III.1 (p. 30). The
                      regression results (estimated coefficients and their standard errors) are
                      reported in table III.2 (p. 30).


                      The bidding systems used by the WIG agencies can be classified into three
Effect of Bidding     categories: competitive sole source bids (SOLE-BID), competitive multi-
Systems on Adjusted   source bids (MULTI-END), and negotiated open market bids.
Price                 Economic theory suggests that manufacturers will offer higher rebates
                      under a competitive bidding system than under a negotiated open
                      market approach. Winning or losing a competitive bid can have a major
                      impact on an infant formula manufacturer’s market share. In addition to
                      the sales of formula to WIGparticipants, sales of formula to purchasers
                      not in the WIGprogram may increase as well-the scxalIed spillover
                      effect.

                      In contrast to a competitive bid system, the open market rebate
                      approach tends to maintain the preexisting relative market shares.*
                      Offering an open market rebate wiII not increase a manufacturer’s
                      market share; declining to offer a rebate will not decrease it. An open
                      market rebate appears to reduce a firm’s profits since such rebates
                      represent an additional expense without offsetting sales gains for the
                      manufacturer.

                      ‘One WIG agency with an open market contract did not provide complete information on its rebate
                      contract and was not, therefore, included in the regression analysis. Two other WIG agencies with
                      rebate contracts used retail distribution to serve only a portion of their WIG participants; the popula-
                      tion f&urea for these two agencies were adjusted accordingly.

                      *Under the preferred provider approach, participant8 are enmuraged to buy only those brands that
                      give rebates. Only one WIG agency used this approach.



                      Page 26                                       GAO/EEMO-122       Infant Formula in the WIG Program
--
                           Appendix     IfI
                           Economic     Determinanta   of the Adjaated   Price
                           for Infant    Formula-GAO      Analysis




                           Konetheiess, some manufacturers may prefer an open market approach
                           to a competitive sole source approach precisely because the former
                           maintains relative market shares. In fact, one explanation for the exis-
                           tence of open market rebates is that manufacturers wish to forestall WIG
                           agency adoption of the competitive sole source approach.

                           Rebates under the multi-source approach may tend to be higher than
                           open market rebates, but lower than competitive sole source rebates.
                           The gains from winning a competitive multi-source bid may be lower
                           than the gains from winning a sole source bid since, by definition, more
                           than one manufacturer may win a multi-source bid. There is a cost asso-
                           ciated with losing a multi-source bid (that is, being shut out of the WIG
                           market), but it is impossible to lose an open market bid.


                           We controlled for the size of the WIGinfant population (WICPOP), the pro-
Effect of Population       portion of the eligible population served (ELIGtW) in 1989, and whether
on Adjusted Price          the WIG program was operated by an Indian agency (INDIAN). The size of
                           the WIGpopulation may serve as a proxy for size of the non-wIc infant
                           population, indicating the potential for profitable spillover business.
                           Indian WIC agencies may receive lower rebates, in part, because the size
                           of the non-wrc population relative to the WIGpopulation is less than for
                           state WIGagencies. Rebates may also be lower in areas that serve a high
                           proportion of their eligible population - compared with those that
                           serve a low proportion - because there is less potential for expansion.
                           Manufacturers may also be reluctant to offer high rebates in such cases
                           because savings not used by a WIG agency are returned to FNSand dis-
                           tributed to other agencies that may be served by competing firms.

                       4
                           WIGagencies in states where infant formula is produced may be able to
Geographic Cost            obtain formula at a lower price, relative to the price paid in other states,
Differentials              if transportation costs affect the manufacturers’ costs of providing
                           infant formula. To account for this possibility, we included a dummy
                           variable, equal to 1, if any of the three major infant formula manufac-
                           turers operated a production facility within the state (MFGSTATE). A set
                           of regional dummy variables was also included to control for any geo-
                           graphical cost differentials that might affect the adjusted price.




                            Page 27                                        GAO/HRD9@122   Infant   Formula   in the WIG Program
                     Appendix UI
                     Economle Determinants of the Adjusted Price
                     for Infant Formnla-GAO Analyeia




                     The adjusted price for a particular brand is calculated by subtracting
Calculating the      the rebate amount, if any, as of June 1, 1989, from the wholesale list
Average Adjusted     price for a 13-ounce can of milk-based formula.” We first determined the
Price                wholesale prices for each of the three major manufacturers-Ross,
                     Mead-Johnson, and Wyeth-Ayerst-based        on contract information pro-
                     vided by WIGdirectors in their questionnaire responses. In WIG areas that
                     use the open market approach, the average adjusted price paid by the
                     WIGagency (PRICE)was computed by averaging each firm’s adjusted
                     price, using national manufacturer market shares as weights.4

                     For competitive sole source bids, we assumed, on the basis of question-
                     naire responses, that the contract brand represented 95 percent of the
                     formula purchased, with the remaining 5 percent purchased from other
                     manufacturers. Consequently, we averaged the adjusted price of the
                     contract brand with the average adjusted price of two noncontract
                     brands, using the weight of 0.95 for the first and 0.05 for the second.”

                     For competitive multi-source bids, all of the formula purchased is
                     assumed to earn a rebate. The relative national market shares of the
                     contract manufacturers were used to compute the weighted average-
                     adjusted price for these bids.


                     We estimated the regression model by the method of ordinary least
RegressionAnalysis   squares. The following are shown in table 111.2:the estimates of the
Results              regression coefficients, the standard error for each of the estimated
                     coefficients, the t-statistic for the null hypothesis that the true param-
                     eter value is equal to zero, and the mean value of each variable.

                     An estimate is considered statistically significant if the probability is
                     low that the true value of the coefficient is equal to 0. We chose as our
                     criterion a significance level of 0.05; that is, we required that the

                     30ut of a total of 94 retail rebate contracts awarded, 26 had not been implemented as of <June1. 1989.
                     For contracts awarded, but not implemented, we calculated the adjusted price usmg the rebate
                     amount specified in the contract. The total number of retail rebate contracts reflects the award of
                     multiple contracts by agencies using open market, multi-source, or preferred provider approaches.
                     4Wholesale pricesfor a 13+unce can of milk-based formula and national market shares by manufac-
                     turer were Rcss, $1.583,56 percent; Mead Johnson, $1.560,36 percent; and Wyeth-Ayerst. SI 445.9
                     percent.

                     %ecause one state, which uses a competitive multi-source approach, awarded only one <ymrract. It
                     was treated as if it used a sole source competitive approach in the calculation of ad~usttd pnt’+sThe
                     appropriawmarket shares were used to obtain the weighted average price of the noncnnrrac’r brand
                     formula



                     Page 28                                      GAO/HBDsOl22       Infant Formula in the HI<’ Program
-
    Appendix     III
    Economic     Detemdanta    of the Adlaeti    Price
    for Infant   Fomula-GAO      AMIYS~S




    probability of the true coefficient being 0 is no greater than 0.05. The
    critical t-statistic (two-tailed test), given the size of our data set, is
    approximately 2.0.

    After controlling for the variables discussed above, the factor that had
    the largest impact on adjusted price is the type of bidding approach
    employed by the WIGagency. Competitive sole source bids produced
    adjusted prices that were $0.36 lower than open market adjusted prices.
    Competitive multi-source adjusted prices were $0.24 lower than open
    market adjusted prices.6 These differences are statistically significant at
    the 5-percent level.

    The size of the WIG population was not an important determinant; that
    is, on average, states with large WIG populations did not obtain formula
    at a lower cost than states with small WIGpopulations. The percentage of
    the eligible WIG population served did influence, statistically, the
    adjusted price, although the magnitude of the effect was relatively
    small. An increase of 10 percentage points in the proportion of the eli-
    gible population served was associated with an adjusted price that was
    $0.04 higher.’

    On average, Indian WIGagencies that have retail rebate contracts pay
    $0.55 more for infant formula than state WC agencies that have retail
    rebate contracts. The regression results indicate that part of the differ-
    ence ($0.17) takes place because all of the Indian WIG agencies with
    retaiI rebate contracts had open market contracts; 50 percent of the
    states had competitively bid contracts (either sole source or multi-
    source). The fact that Indian WIGagencies serve a higher proportion of
    their eligible population, on average, than state WIGagencies explains an
    additional $0.11 of the difference.8 The remainder ($0.27) of the differ-
    ence between the adjusted price paid by Indian WIGagencies and the
    adjusted price paid by state WIGagencies cannot be explained by the fac-
    tors we considered in our economic analysis.

     6Although the point esthatm imply that sole source competitive bids lead to lower adjusted prices
     than multiilource competitive bids, they are not statistically different from each other at standard
     significance levels.

     ‘We also tried limiting the analysis to states only and, to control for the size of the non-WIG market,
     lncludlng the state population and the number of bii       in the state since 1980. These variables were
     not statistically significant in the regres&ons. When we limited our attention to programs adminis-
     tered by state WIG agencies, the percentage of the eligible population served was no longer stausti-
     ally slgnlflcant.

     sOn average, Indian WIG agencies served 72.6 percent of their eligible population; non-lndlan WC
     agencies served 47.8 percent.



     Page 29                                       GAO/HIUMO-122       Infant   Formula   in the WIG Program
                                              Appendix     III
                                              Economic     Determinanta   of the A4jjusted   Price
                                              for Infant   Formula-GAO       Analysis




                                              Lastly, neither the set of regional dummy variables nor the state-manu-
                                              facturing variable was an important determinant of acijusted price.

Table 111.1:Definition of Variables Used in
Regression Analysis                           Variable                      Description
                                              SOLE-BID                      Equals 1 If WIC agency uses sole source competrtrve brddrng, 0
                                                                            otherwrse
                                              MULTI-BID                     Equals 1 If WIC agency uses multi-source competmve brddrng
                                                                            (that is, “Colorado model”), 0 otherwise
                                              WICPOP                        Average monthly WIC infant population (June 1986 to May 1989)
                                                                            In thousands
                                              MFGSTATE                      Equals 1 if Ross, Mead Johnson, or Wyeth-Ayerst has an Infant
                                                                            formula manufactunnq facrlitv In the state, 0 otherwise
                                              ELIG89                        Proportion of the eltgtble population served by the WIC agency In
                                                                            fiscal year 1989
                                              INDIAN                        Equals 1 if the WIC agency represents an Indian tribe, 0 otherwtse
                                              MIDWEST                       Equals 1 if the WIC agency IS located In the Midwest, 0 otherwrse
                                              WEST                          Equals 1 if the WIC agency is located in the West, 0 otherwrse
                                              SOUTH                         Equals 1 if the WIG agency is located In the South. 0 otherwise
                                              PRICE                         Weighted average adjusted contract pnce (wholesale pnce mmus
                                                                            rebate amount) as of June 1, 1989


Table 111.2:Regres8ion Results
                                                                                     Parameter          Standard
                                              Variable                                estimate              error           T-stat           Mean
                                              INTERCEPT                                     0.53              0.10            5.39
                                              SOLE-BID                                    -0.36               0.05          -7.91              0 32
                                              MULTI-BID                                   -0.24               0.09          -2 8.5             0 05
                                              WICPOP                                  -2.OE-04          -8.2E-04            -0 25             18.09
                                              MFGSTATE                                    -0.01               0.07          -0 11              0 07
                                              ELIG89                                        0.40              0.15            2.64             0.54
                                              INDIAN                                        0.27              0.06            4 45             0.25
                                              MIDWEST                                     -0.04                0.06         -0 66              0.25
                                              WEST                                          0.03               0.06           OS8              0.38
                                              SOUTH                                         0.01               0.06           0.12             0 21
                                              PRICEa                                                                                           0.69
                                              Note: Number of observations, 56
                                                    Adjusted R-square, 0.824
                                                    F statistic, 29.67
                                                    Probabrlity of F statrstrc, O.ooOl
                                              aPRICE,representing adjusted price, IS the dependent variable




                                              Page 30                                         GAO/?iRD%SlZZ    Lnfant Formula   in the BIG F’rogram