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May 23, 2022, 10:12 a.m. EDT

Baby-formula industry was primed for disaster long before key factory closed down

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By Kevin Ketels

The conditions that led to a  shortage of baby formula  were set in motion long before the February 2022 closure of the Similac factory  tipped the U.S. into a crisis .

Retailers nationwide  reported supplies of baby formula were out of stock  at a rate of 43% during the week ended May 8, 2022, compared with less than 5% in the first half of 2021. In some states, such as  Texas and Tennessee , shortages were over 50%, which has prompted parents to  travel long distances  and  pay exorbitant sums of money  to grab dwindling supplies of formula for their babies.

News that the Food and Drug Administration and Similac-maker Abbott /zigman2/quotes/203724446/composite ABT +3.05%   have reached a deal  to reopen the formula factory in Sturgis, Mich., is welcome news for desperate parents, but it will do little to alleviate the shortage anytime soon. This is in no small part because of the very nature of America’s baby-formula industry.

research and teach supply chain management , with a special focus on the healthcare industry. The closure of the Similac factory may have lit the fuse for the nationwide shortage, but a combination of government policy, industry market concentration, and supply-chain issues supplied the powder.

What prompted the baby formula shortage

On Feb. 17, Abbott  initiated a voluntary recall  after  four infants  were hospitalized with infections from the bacteria  Cronobacter sakazakii —two of them died—after consuming baby formula manufactured in their Sturgis facility. The factory was also shut down.

The FDA has identified no new cases but has  not yet approved reopening  the Sturgis facility, which is responsible for about half of Abbott’s U.S. supply. Abbott said it  entered into a consent decree  with the FDA that paves the way to reopening the facility once certain conditions are met.

Shortages of baby formula have led major U.S. retailers including Target /zigman2/quotes/207799045/composite TGT +2.46% , CVS /zigman2/quotes/209664499/composite CVS +2.33% , Walgreen /zigman2/quotes/203410933/composite WBA +1.86% s and Kroger /zigman2/quotes/206215053/composite KR +1.51% to  restrict the amount of formula  a consumer may purchase. These shortages  are disproportionately hurting low-income families  and those who do not have the resources to travel long distances to find alternative sources of baby formula.

The root of the problem begins with a concentration of production.

Two companies—Abbott and Reckitt Benckiser /zigman2/quotes/205841729/composite RBGLY +1.11% /zigman2/quotes/206856088/delayed UK:RKT +1.20% , which makes Enfamil— dominate the industry with about 80% of the U.S. market . Nestlé /zigman2/quotes/208115528/delayed CH:NESN +0.26% , which sells baby formula in the U.S. under its Gerber brand, controls another 10%.

Part of the reason these companies are so entrenched in their position is that Abbott, Reckitt and Nestlé  are the only makers approved  by the U.S. government to provide baby formula through the Special Supplemental Nutrition Program for Women, Infants and Children,  known as WIC , which provides supplemental food to low-income families.

WIC, which  reimburses companies at 15%  of the wholesale cost,  is responsible for 92%  of supermarket sales of milk-based powder formula in 12-to 16-ounce containers and 51% of all sales in other sizes.

The federal government provides WIC grants to each state, which then contracts with one of the three companies. While WIC is a critical program to feed the most vulnerable, government support of this program has the unintended consequence of creating a de facto monopoly in each state.

The amount of WIC funding to these three established companies makes it difficult for any startup to make significant inroads in the baby formula industry. There is little chance they can capture the market share necessary to justify a significant investment. Since only a handful of manufacturing facilities are approved for production of baby formula in the U.S., startups don’t have the volume required to produce in these facilities.

Import restrictions

Another reason for the intense concentration is import controls.

About 98% of the formula consumed  in the U.S. is produced domestically, whether by a U.S. or international company. While facilities abroad such as those in Mexico, Chile, Ireland and the Netherlands meet the FDA’s nutrition standards, a  failure to meet its labeling guidelines  prevents them from exporting to the U.S. As a result,  some consumers order unapproved formula  over the internet from Europe and elsewhere, which may then be confiscated at the border.

International manufactures also face high tariffs, which  can be as high as 17.5%  depending on volume. That’s one reason Canadian producers, which are subsidized by their government,  have mostly steered clear  of the U.S. market. And the United States Mexico Canada Agreement, which came into force in 2020, included a provision that made it even harder for Canada to ship baby formula south in an effort to protect domestic producers.

‘Lean’ supply chains

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25.35
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1.72%
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