Everything was going great. Manufacturers had consistent volume growth, regular price increases twice a year, double-digit
earnings growth, and the development of new products that enhanced the quality of life for customers. Much of that growth,
however, was fueled by a federal government program that offered subsidized access to products for citizens with the lowest
incomes. For a while, the good times continued. Then, one day, the state governments that administered the program started
to balk at its ever-increasing cost and got an idea to make it both cheaper and more expansive. That marked the beginning
of the end of the world as the companies knew it.
The industry in question was not pharma, but the $1.5 billion infant formula industry. Until the 1980s, infant formula was
a high-growth, high-profit business for companies such as Bristol-Myers Squibb (through its Mead Johnson division), Abbott
Laboratories (through its Ross Products division), and American Home Products (now Wyeth).
But then, in 1983, the US federal government launched the Special Supplemental Nutrition Program for Women, Infants, and Children
(WIC), and within a few years the business underwent a remarkable change for the worse. The program began as a way to offer
free formula, paid for by federal and state funds, to the poorest 20 percent of new mothers. Within 10 years, nearly half
of US customers—some two million of the four million babies born annually—were receiving their formula gratis. Through rebates
and contract negotiations, the financial burden of the subsidy, meanwhile, shifted in large part onto the shoulders of the
infant formula manufacturers.
From 1992 to 1994, BMS, Abbott, and Wyeth saw their US profits level off, decline, and even disappear. By 1994, Wyeth, for
all intents and purposes, had withdrawn from bidding for WIC contracts, and it subsequently exited the US market in 1996.
For several years thereafter, Ross and Mead Johnson fought a costly war for brand share in a series of state-by-state, winner-take-all
battles for market access, ultimately squeezing profitability out of the fastest-growing and highest-consumption segment of
the market.
Why does this story matter to the pharma industry? Because there is good reason to think the dynamic that drove the profits
out of infant formula is about to be repeated—this time in the pharmaceutical market—thanks to the Medicare drug benefit.
Superficially, the markets and the programs may seem not to have much in common. But the underlying market logic is strikingly
similar, as pharma may learn.
Evolution of the Infant Formula Business
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When WIC began, executives at formula manufacturers did not anticipate the consequences of what appeared to be a benign, even
attractive program. They should have. Consumers, governments, and competitors all behaved in a very predictable way once a
government subsidy was introduced. The question now is whether pharma can learn from another industry's experience while there
is still time.
An Industry Evolves
For nearly 50 years, the infant formula industry evolved slowly, with few innovations either in products or marketing/sales
models. The introduction of WIC, however, led to customer, regulatory, and competitive actions that quickly rewrote the rules
for success. The process took place as a sequence of six steps:
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