Procurement in welfare programs: Evidence and implications from WIC infant formula contracts

TL;DR

This paper investigates how government procurement via auctions in the WIC infant formula program influences market dynamics, manufacturer behavior, and consumer welfare, revealing significant effects on demand, costs, and prices, with policy implications for procurement mechanisms.

Contribution

It models manufacturer pricing strategies considering WIC consumer inelasticity and regulation, and evaluates the impact of procurement mechanisms on market outcomes and competition.

Findings

Winning WIC auctions increases non-WIC demand.

Procurement reduces manufacturers' costs.

Switching to a rebate mechanism benefits consumers and small manufacturers.

Abstract

This paper examines the impact of government procurement in social welfare programs on consumers, manufacturers, and the government. We analyze the U.S. infant formula market, where over half of the total sales are purchased by the Women, Infants, and Children (WIC) program. The WIC program utilizes first-price auctions to solicit rebates from the three main formula manufacturers, with the winner exclusively serving all WIC consumers in the winning state. The manufacturers compete aggressively in providing rebates which account for around 85% of the wholesale price. To rationalize and disentangle the factors contributing to this phenomenon, we model manufacturers' retail pricing competition by incorporating two unique features: price inelastic WIC consumers and government regulation on WIC brand prices. Our findings confirm three sizable benefits from winning the auction: a notable spill-over effect on non-WIC demand, a significant marginal cost reduction, and a higher retail price for the WIC brand due to the price inelasticity of WIC consumers. Our counterfactual analysis shows that procurement auctions affect manufacturers asymmetrically, with the smallest manufacturer harmed the most. More importantly, by switching from the current mechanism to a predetermined rebate procurement, the government can still contain the cost successfully, consumers' surplus is greatly improved, and the smallest manufacturer benefits from the switch, promoting market competition.