The Special Supplemental Nutrition Program for Women, Infants and Children (WIC) was established in 1972 to provide food, nutrition education, and health care referrals to low-income pregnant and postpartum women, infants, and young children. The program is administered by FNS in conjunction with state and local health departments and related agencies. WIC is almost entirely federally funded. WIC is not an entitlement program; Congress does not set aside funds to allow every eligible individual to participate in the program. Instead, WIC is a federal grant program for which Congress authorizes a specific amount of funds each year. USDA provides funding for food and nutrition services and administration. Both funding and participation have increased each year since fiscal year 2000. Congress also typically provides for a contingency fund to ensure that adequate resources are available for the program if unanticipated costs arise. WIC participants typically receive food benefits in the form of vouchers or coupons that they redeem at authorized retail vendors to obtain, at no cost to the participants, certain approved foods, including infant formula. State WIC agencies then reimburse the retail vendors for the food purchased by WIC participants. Since 1989, state WIC agencies have been required by law to contain the cost of infant formula using a competitive bidding process to award sole-source contracts unless they can demonstrate that an alternative method would yield the same or greater cost savings. Manufacturers agree to provide a rebate to the state WIC agency for every can of infant formula purchased under the WIC contract, and the state awards the contract to the bidder offering the lowest net wholesale price after subtracting the rebate from the cost of infant formula. In exchange, the state provides the contract brand of infant formula to most infants enrolled in the program except those that are breastfeeding exclusively and those with a medical condition that requires the use of a non-contract infant formula. Rebates have become an important source of funding for the WIC program. In 2004, rebates totaled more than $1.6 billion and funded the benefits provided to about a quarter of WIC participants. Contracts for WIC infant formula are between states and infant formula manufacturers. States are responsible for issuing requests for bids and drafting contract provisions according to state contracting requirements. Typically, a WIC agency will draft a bid solicitation and obtain state approval for the contract language. Once the state approves the solicitation, the WIC agency will submit it to the FNS regional office for review. The regional office ensures that the contract adheres to all federal requirements and may suggest ways to improve the contract. FNS headquarters reviews the contract for final approval. After approval, the contracting process is conducted by the state. Infant formula comes in three physical forms: liquid concentrate, powder, and ready-to-feed. Infants may receive up to 31 13-ounce cans of liquid concentrate per month through WIC, or roughly the equivalent amount of powdered or ready-to-feed infant formula. Most infants are provided an infant formula that is covered by the state’s cost-containment contract. There are three categories of infant formula provided to WIC participants: Contract brand infant formula is produced by the contract manufacturer and is suitable for routine use by the majority of healthy full-term infants. These include milk-based and soy-based infant formulas and could include milk- and soy-based infant formulas enhanced with DHA and ARA, lactose-free infant formula, added-rice infant formulas, and easy-to-digest infant formulas. “Contract brand infant formula” also includes new infant formulas introduced by the contract manufacturer after the contract is awarded, with the exception of infant formula under the following “exempt” category. Exempt infant formula is represented and labeled for use by infants with medical conditions such as inborn errors of metabolism, low birth weight, or other unusual medical or dietary problems that require that they use a more specialized infant formula. Non-contract brand non-exempt infant formula is all infant formula produced by a manufacturer other than the contract manufacturer that is suitable for routine use by the majority of healthy full-term infants. FNS regulations require local WIC agencies to obtain medical documentation to provide all exempt infant formulas and all non-contract, non-exempt infant formulas. Medical documentation, for these purposes, is a determination by a licensed health care professional authorized to write medical prescriptions under state law. A licensed health care professional must make a medical determination that an infant has a medical condition that dictates the use of these infant formulas. State spending on infant formula depends on the discounts, in the form of rebates, that states receive from manufacturers, and use of non-contract infant formula. Rebates are the most important factor driving state spending on infant formula because such a large proportion of WIC infant formula is purchased under cost-containment contracts with manufacturers. According to infant formula manufacturers, the attractiveness of a WIC contract depends, at least in part, on factors over which states have some control, including the extent to which a WIC contract will help a manufacturer market its products to non-WIC consumers; state-level administration of WIC contracts; and the provision of powder, concentrate, and ready-to-feed infant formula to WIC participants. These factors, in turn, could affect whether or not a manufacturer bids on a contract and the level of rebates offered by the manufacturers. The provision of non-rebated infant formula also affects state spending. In 2004, states received rebates on approximately 92 percent of the infant formula provided to WIC participants, and saved, on average, 93 percent off the wholesale price. As a result, states paid an average of $0.20 per 13-ounce can of milk-based infant formula with a wholesale price of $2.60 to $3.57. However, while average rebates were high, rebate levels varied significantly by state. For example, in 2004, Virginia and South Carolina were paying as little as $0.07 per can of milk-based concentrate after rebates, while New York was paying $0.80 per can after rebates. Representatives of the three infant formula manufacturers identified several factors that influence how “attractive” they find a state contract. The attractiveness of a contract, in turn, could influence whether a manufacturer bids on a contract and the size of the rebate offered. Many of the factors cited by manufacturers are things over which states have at least some control. Shelf space and product placement: WIC-brand infant formulas may get more shelf space than competing brands, particularly in stores that serve areas with large concentrations of WIC participants. Because WIC participants purchase such a large share of infant formula in some stores, retailers tend to stock more of the WIC brand of infant formula. In addition to shelf space, WIC-brand products may be placed at eye level so that they are easy to spot. All three infant formula manufacturers noted the importance of shelf space and product placement to their marketing strategies. In addition, 31 of the 51 state WIC directors that responded to our survey felt that shelf space was moderately, very, or extremely important to manufacturers in determining how much they bid on an infant formula contract. While WIC agencies do not have direct control over shelf space and product placement, some include stocking requirements in their contracts with vendors. State policies regarding authorization of WIC vendors can also impact manufacturers’ access to non-WIC consumers. Some states have authorized WIC vendors that sell exclusively or primarily to WIC participants. Manufacturers have less access to non-WIC consumers if more WIC participants purchase their infant formula at these “WIC-only” stores. In those cases, retailers that serve the non-WIC population in the area may be less likely to focus on product placement or devoting shelf space to the WIC brand—two factors that benefit manufacturers in their drive to reach non-WIC consumers. Physician and Hospital Recommendations: Having WIC contracts could also benefit manufacturers through physician recommendations. State WIC programs often work with physicians to educate them about the program and the requirement that most WIC participants use the contract brand of infant formula. Physicians may decide to recommend the WIC brand of infant formula to all patients to avoid having to differentiate between those enrolled and not enrolled in WIC. Similarly, some hospitals agree to provide WIC-brand infant formula to new mothers so that they won’t have to switch infant formulas after they leave the hospital. It may be easier for hospitals to provide the WIC-brand infant formula to all new mothers. Moreover, two of the infant formula companies that participate in the WIC market are divisions of pharmaceutical companies that primarily market their products directly to physicians and hospitals while also marketing, though to a lesser extent, directly to consumers. States vary in the extent to which they emphasize doctor and hospital outreach. Product Innovation: All three manufacturers cited the central role of product innovation in their business strategies. Manufacturers seek to compete on the basis of product innovation and product quality despite the fact that infant formula is a relatively homogeneous product. Manufacturers said that certain state practices could make it more difficult to pursue their core strategy of innovation, and the development, distribution, and marketing of new products. These practices include the use of long-term contracts, requirements that manufacturers notify states of product changes in advance of introducing new products into the market, provisions that allow states to unilaterally extend contracts without requesting the consent of the manufacturer, state restrictions on the ways in which manufacturers market their infant formula, and restrictions on their interactions with physicians. While these state practices could inhibit innovation, many are put in place to protect states from increases in infant formula costs. State Billing Systems: All three manufacturers cited the accuracy of state billing systems as a key factor they consider when developing bids, and all stated that the vast majority of state billing systems need improvement. One manufacturer said that most states rely on antiquated information technology that is prone to costly billing errors.