Testing Vertical Relationships in the US Infant Formula Market: Implications for Government Costs and Welfare

The U.S. Special Supplemental Nutrition Program for Women, Infants, and Children (WIC) provides free infant formula to low-income households, serving around 39% of U.S. infants. As WIC’s single most expensive benefit, infant formula accounts for around half of the total WIC food costs. To reduce government costs, WIC awards exclusive contracts to manufacturers offering the lowest net price (i.e., wholesale price minus rebate) to the government in each state via public auction, effectively creating monopolies in the WIC market. The broader implications of this policy hinge on vertical relationships between manufacturers and retailers, which remain poorly understood. I identify the vertical relationship as best characterized by two-part tariffs (TPT), where retailers decide retail prices and pay fixed fees to manufacturers and wholesale markups are zero. This finding challenges the common but untested resale price maintenance (RPM) assumption in the literature. Counterfactual simulations show that TPT is more efficient than RPM, yielding higher consumer and total surplus while reducing government costs through lower total markups at equivalent net prices. Specifically, under RPM, average retail prices would be 3.8% higher, consumer surplus would be 7.4% lower, and producer surplus would be 2.2% higher under the current design of WIC. These findings demonstrate that conduct assumptions critically shape welfare outcomes.