When mothers threw a can of baby formula into the shopping cart in 1981, it cost about $1 a pop. In 10 years' time, the price has more than doubled, far outpacing increases in inflation or the price of milk -- the major ingredient in prepared infant food.
State welfare agencies, which account for a third of infant formula sales, for years have complained the loudest about the steady rise in prices, but the Reagan administration never pursued the issue. Now, however, in a major break with the antitrust policies of the past, the Bush administration is paying attention.
Initiating what many consider to be one of the government's most aggressive antitrust inquiries in a decade, the Federal Trade Commission last May began an investigation into pricing practices of the infant formula industry, a business dominated by three major pharmaceutical giants -- Abbott Laboratories, American Home Products Corp. and Bristol-Myers Squibb Co. The trio controls 95 percent of the $1.5 billion infant formula market.
"The information we do have raises competitive questions," Kevin J. Arquit, director of the FTC's Bureau of Competition told Congress. In September, the FTC stepped up the probe by issuing subpoenas that compelled the industry's major players to turn over thousands of documents that government lawyers will scour for any hint of illegal pricing patterns.
The First Salvo
Earlier this month, Florida became the first state to file a civil suit charging the top three formula makers with breaking antitrust laws by conspiring to fix prices and drive up the cost of their product. "This conspiracy ... exploits young mothers who often have no choice in whether or not to buy infant formula," said Florida Attorney General Bob Butterworth.
Critics of the industry, chief among them state officials, say an investigation of possible price-fixing in the business is long overdue. The companies say only that they have done nothing wrong. Some industry observers even suggest the government's new aggressiveness is political, aimed at keeping down costs for infant formula and other health-care products, from medicine to tongue-depressors.
"It's a lovely political thing to get on this band wagon," said Robert M. Goldman, analyst at Dean Witter Reynolds Inc. in New York. "You're helping mothers and children. But the bottom line is that government is trying to indirectly make pharmaceutical companies keep a lid on prices."
Whether anything comes from this particular investigation, legal scholars and politicians agree, the FTC's willingness to undertake it at all signals a new activism on antitrust matters, possibly even a desire to break legal ground, by an agency that many accused of taking too much of a laissez-faire approach toward business. At the least, Goldman and others say, the investigation revives a complex debate about how businesses set prices and to what extent government should scrutinize that process.
"This is a major move in the right direction, and I hope it's a harbinger of things to come," said Sen. Howard Metzenbaum (D-Ohio), chairman of the Senate Judiciary Committee's subcommittee on antitrust. "In the Reagan years, there was an absolute effort to let business do whatever it wanted."
Amazing in itself to many legal scholars is the FTC's willingness to review information on infant formula pricing collected by Metzenbaum, a populist whose activist philosophy often has put him at loggerheads with Republicans in the Reagan administration.
As with any such investigation, the FTC's Arquit said his agency will be looking for evidence of standard, clear-cut price fixing, what scholars describe as old-fashioned collusion where executives meet in a hotel room or on the phone and explicitly agree on what they will charge.
But what has captured the legal community's attention is that the FTC also plans to look for what are called "facilitating devices," signals between companies that lead to anticompetitive behavior such as price fixing.
Lawyers describe the "facilitating device" theory as an esoteric and largely untested antitrust legal doctrine formulated in the 1970s, disregarded under Reagan and now dusted off and resurrected by the Bush administration's FTC. With it, "the FTC may be trying to break new ground" in defining anticompetitive behavior, said New York University law professor Eleanor Fox.
The investigation signals "a recognition that there is more to an anti-cartel policy than detection and enforcement against outright price fixing," said antitrust lawyer Robert Pitofsky, who also teaches at Georgetown University law school and is a former FTC commissioner.
The infant formula industry could prove a good testing ground for the "facilitating device" theory, lawyers say. It has a handful of competitors who watch each other closely and who make a product that differs little from company to company, in large part because federal law sets strict standards for infant formulas. All of this adds up to an environment ripe for uncompetitive behavior, experts say.
Specifically, the FTC will examine the intent of the companies and whether they have had "independent legitimate business reasons" for raising prices. The wholesale price of infant formula sold by the top three companies rose an average of 155.4 percent from December 1979 to December 1989, according to the Center on Budget and Policy Priorities, a nonprofit advocacy group in Washington. By comparison, the price of milk rose 36.4 percent and the price of groceries overall rose 50.8 percent in the same period.
Firms Cite Costs, Controls
Major infant formula companies have blamed price increases on two factors: the rising cost of maintaining quality controls required by the government and the rising cost of research and development in a variety of health-care products they make. Consumer groups dispute the notion that production costs have risen substantially and challenge the idea that baby formula profits should be used to fund a company's research in other product areas.
But even if the companies had legitimate reasons for raising prices, it doesn't necessarily get them off the hook under the "facilitating device" theory, which doesn't require that signals be intentional to be improper. "There may be situations where there are competitive reasons for an action that may be outweighed by the potential for anticompetitiveness, and the FTC should be able to step in," said Columbia University law professor Harvey J. Goldschmid.
In addition to the top three infant formula makers, the FTC has subpoenaed two relative newcomers to the U.S. market: Carnation Co., a subsidiary of Swiss conglomerate Nestle S.A., which entered in 1988, and Gerber Products Co., which entered in 1989 through a joint venture with one of the exiting top three formula makers, Bristol-Myers. Together, Nestle and Gerber have made hardly a dent in the market, controlling less than 3 percent of domestic sales.
The top three formula makers often note the entry of Nestle and Gerber as evidence the market is competitive. But others question whether Nestle, which dominates the infant formula market outside the United States, and Gerber, a major baby food manufacturer that merely markets an infant formula Bristol-Myers makes, qualify as "new" entrants in any sense that would establish with certainty the competitiveness of the industry. Gerber and Nestle are simply too big and too securely footed in baby food products to warrant that distinction, they argue.
The FTC's review of the industry's practices will include a close look at retail price patterns over the last 10 years. It will also focus on the industry's bids for contracts under the federally funded food program for low-income families, Special Supplemental Food Program for Women, Infants and Children, or WIC, which is administered by the states. WIC, accounting for a third of U.S. sales, is the largest single purchaser of infant formula.
Discounts in Step
The industry's upward price movements have tended to move in tandem over the last decade and bids for WIC programs have often been very close in price. FTC officials stress that, in general, parallel price movements such as these are not illegal in themselves. But price increases that occur lock-step among a few dominant companies or that exceed an increase in raw material or other business costs may indicate illegal activity.
As infant formula prices soared in the 1980s, so did demands for discounts from WIC administrators. At the end of 1987, only four states demanded discounts. By the end of 1989, all but one or two states did. The discounts are offered through rebates that have ranged from one-third to two-thirds off the retail price. A boon for states, rebates have proved disastrous for formula makers, said Dean Witter's Goldman. The companies won't reveal costs or profit margins, but Goldman estimates it costs about 89 cents to make, market and deliver a can of infant formula to the grocery shelf. Add in rebates and the result is a loss for companies, he said. The state agencies believe that the top three companies are looking to regain the profits they earned before the era of rebates. As contracts have come up for renewal in several states recently, the companies have sliced discounts, sometimes in half and often to the same levels at about the same time.
If the FTC finds the companies signal such discounts and other price changes, it can force them to stop announcing price changes or other acts that help competitors know in advance which way prices will move.
The FTC also has subpoenaed documents from the American Academy of Pediatrics in Washington, which has fought to keep infant formula makers from advertising. Many baby doctors, though not all, worry that advertising encourages mothers to use formula rather than breast feed, the method many doctors say is better for babies in most cases. Instead of ads, formula makers use free samples and research grants to persuade hospitals and doctors to recommend their products. The result has been that mothers have chosen between very similar baby formulas largely on the basis of their doctor's recommendation.
Gerber broke ranks with the tradition by advertising rather than relying on a large -- and expensive -- sales force. Nestle plans to follow suit this month. Based on the small slice of the market Gerber has captured, however, it seems ads are no match for the doctor's word, analysts say.