A Formula for Failure

Parents in many parts of the United States are irate over a shortage of infant formula that was triggered over THREE MONTHS AGO and has yet to be corrected. Relief may be in sight but the entire incident should raise concerns for the public across many sectors of the economy. We live in a country that controls the most effective military on the planet. We live in a country that can build rockets that can return upright to their launching pad for re-use. When that same country suddenly becomes unable to reliably feed the most dependent segment of the population, it should be clear our political and market forces are dangerously mis-prioritized and require immediate review. Any such review will conclude the factors causing this formula shortage are not just randomly present in the economy, they are applied systemically in nearly every sector of the economy, like a formula. A formula for failure in many areas to come.

The current formula shortage stems from a shutdown of a single manufacturing plant in Sturgis, Michigan owned by Abbott Labs which makes the infant formula product Similac which was consumed by four different infants hospitalized for infections from a bacteria called Cronobacter sakazakii. All of the cases were reported to the CDC and two of the four infants died. The CDC worked with the FDA which conducted an onsite inspection of the Abbott facility beginning January 31, 2022 and later led to the issuance of an administrative letter by the FDA to Abbott on March 18, 2022 identifying shortcomings in Abbot equipment and procedures. Abbott responded to the FDA's findings on April 8 and as of May 11, Abbot stated it could resume production within two weeks of FDA approval and it would take approximately 6-8 weeks for output to flow through the supply chain to reach stores. On May 16, 2022 a consent decree was reached between the FDA and Abbott that seemingly makes the re-opening of the plant more certain.

Everything researched, analyzed, root-caused and assigned to an action plan -- case solv-ed, right?

No. Not so fast.

Let's work this backwards from the present.

Do We Really Have Root Cause?

Coverage of the recent actions taken by Abbot and the FDA to address the supply crunch overlook a crucial issue -- Abbott is denying their plant was the source of the bacteria that led to the hospitalizations and death. Their full press release regarding a consent decree reached with the FDA was posted on their web site

https://abbott.mediaroom.com/2022-05-16-Abbott-Enters-into-Consent-Decree-with-U-S-Food-and-Drug-Administration-for-its-Sturgis,-Mich-,-Plant-Agreement-Creates-Pathway-to-Reopen-Facility

and the same bullet points were added to a rolling journal Abbott has been updating on the event since February

https://www.abbott.com/corpnewsroom/nutrition-health-and-wellness/abbott-update-on-powder-formula-recall.html

It is worth reading Abbot's feedback verbatim:

The facts about what was learned about the cases of Cronobacter have not been widely communicated. After a thorough review of all available data, there is no evidence to link our formulas to these infant illnesses.

It's important to know:

• Abbott conducts microbiological testing on products prior to distribution and no Abbott formula distributed to consumers tested positive for Cronobacter sakazakii or Salmonella.
• All finished product testing by Abbott and the FDA during the inspection of the facility came back negative for Cronobacter and/or Salmonella. No Salmonella was found at the Sturgis facility.
• The Cronobacter sakazakii that was found in environmental testing during the investigation was in non-product contact areas of the facility and has not been linked to any known infant illness. Specifically:
  
  • Genetic sequencing on the two available samples from ill infants did not match strains of Cronobacter in our plant. Samples from ill infants did not match each other, meaning there was no connection between the two cases.
  • In all four cases, the state, FDA, and/or CDC tested samples of the Abbott formula that was used by the child. In all four cases, all unopened containers tested negative.
  • Open containers from the homes of the infants were also tested in three of the four cases; two of the three tested negative. The one positive was from an open container from the home of the infant, and it tested positive for two different strains of Cronobacter sakazakii, one of which matched the strain that caused the infant’s infection, and the other matched a strain found on a bottle of distilled water in the home used to mix the formula. Again, neither strain matched strains found in our plant.
  • The infants consumed four different types of our formula made over the course of nearly a year and the illnesses took place over several months in three different states.

Those aren't your typical mealy-mouthed corporate flack points stating "mistakes were made" or "we didn't do it and we'll never do it again." It would be incredibly stupid for a food manufacturer to lie about things related to DNA similarities and differences which, in theory, can be re-tested and re-proven if doubted, right? (Leave a mental bookmark here. We'll come back to this...)

If Abbott's statements are true, it is possible this entire exercise was a high-tech wild goose chase that wound up imposing far more harm for infants and their parents than it averted. The bacteria involved in this case -- cronobacter -- is a germ found naturally in the environment. It says so right on the CDC's new web page devoted to this issue:

https://www.cdc.gov/cronobacter/infection-and-infants.html

If samples were analyzed by the CDC prior to February 17 and found

• a single variant of the bacteria
• all of the infants came from a single geographic area
• all of the infants used the exact same Abbott product
• all of the infants consumed product from the same plant and the same manufacturing lot
• tests of unopened product from the same lot showed contamination with the bacteria

then closing that plant immediately to clean and correct processes would be a sound action. If you believe Abbott's analysis, the EXACT OPPOSITE happened:

• no closed containers from the homes of any case tested positive for ANY bacteria
• only one case found an open container with bacteria matching the bacteria infecting the infant and that variant matched water in the home used to prepare the formula
• from Abbott's statement, it isn't clear if all of the cases involved the same manufacturing lot or even the same production plant

The point here is that the analysis performed by both the FDA and CDC along with Abbott in hindsight doesn't appear to have identified the actual source of these contaminations. It DOES point out that the ping-pong of communications between the FDA and Abbott didn't seem prioritized to reflect the fact that the shutdown halted production of niche varieties of formula amounting to 50% of supply with most existing supplies on shelves in stores needing to be destroyed as well. In hindsight, the communications involving this event read like the cockpit transcript of a doomed flight as the pilot and co-pilot calmly roger each other as they follow procedures and suspect instruments and fly a plane into the side of a mountain. As of May 21, the FDA has not actually given Abbott final approval to re-open the plant.

What Happened With Communication?

The Abbott plant was closed on February 17, 2022. Letters bounced back and forth on March 18 and April 8 between the FDA and Abbott. Abbott issued its press release on May 11 stating it could resume operations in two weeks after approval. It's now May 21 and FDA Director Robert Califf has still not officially provided approval for the Sturgis plant to re-open. In light of the analysis above, the first immediate question is why not? If you believe Abbott's analysis, the plant was shut down because an infant died who consumed their product and while there is no link between THAT product and other issues the FDA found by inspecting the plant, the FDA is using unrelated deaths to force Abbott to correct other issues. The equivalent of investigating four car wrecks in Honda Accord vehicles then shutting down Honda's Marysville, Ohio plant for minor violations found in the plant around the time of the four wrecks that had nothing to do with the wrecks.

Or is it?

Here is a link to a PDF copy of the 483 administrative letter sent by the FDA to Abbott on March 18 that summarizes the FDA's findings.

https://www.fda.gov/media/157708/download

I have attempted to translate them from administrative-ese to English for review here:

• Observation 1 -- lack of processes to prevent contamination of the product by microorganisms. Samples found to contain cronobacter sakazakii were collected on February 1-2, 2022 from hoppers in "high care" areas which are used to place scoops inside the final product. Three other samples were collected which tested positive were collected from floor and door areas near dryer equipment in "medium care" areas.
• Observation 2 -- failure to ensure all surfaces which may contact infant formula are maintained to prevent contamination from any source. Internal Abbott records show patterns of cracking and pitting in dryer equipment dating back to 2018 which have not been corrected.
• Observation 3 -- failure to provide final root cause for four FDA consumer complaints regarding cronobacter sakazakii and failure to retain samples used in the investigation for secondary review. These are the four cases that led to the shutdown.
• Observation 4 -- failures by employees to wear proper "protective apparel" and failure to utilize cleaning processes upon entering clean rooms. Abbott's response stated the observations involved outside contractors who had been brought in to work on dryer equipment. The FDA's point is that procedures call for ALL workers to take off street shoes ("non-captive shoes" in the vernacular) and don "safety shoes" when entering clean areas and Abbott didn't enforce that.. Some workers were seen wearing clean shoes off the factory floor, indicating they were likely walking between clean / non-clean areas and possibly tracking contaminants into clean areas.

The most obvious point to make from reviewing the 483 letter is that if Abbott failed to preserve its samples used to refute culpability when according to Abbott they PROVED Abbott's case, Abbott is either a) scientifically / operationally incompetent or b) lying about the results. Neither answer is a good look for a firm making nutrition products.

If in reality Abbott concluded the DNA of any contaminations found in its plant failed to match the DNA of the bacteria in any of the children, then closing the FDA cases without root cause would be correct -- the root causes lie outside Abbott's responsibility. However, that argument is weakened or destroyed entirely if Abbott failed to save the test results per its own existing operating practices.

What's My Motivation?

The FDA letter indicates that some of their findings data back as far as 2018. Specifically, dryer equipment used in production seems to be prone to wear and tear that itself makes the equipment more susceptible to contamination or harder to clean to avoid contamination. The findings also seem to indicate that Abbott hasn't done much to correct those problems.

To understand why, the "Get Shorty" question has to be asked... What's my motivation?

If you are Abbott, the answer is pretty much "nothing." The formula market has been HEAVILY concentrated for thirty years with roughly 90% of the market controlled by a few players. In 2022, Abbott controls roughly fifty percent of the market, Meade Johnson controls thirty one percent and Nestle supplies another eight percent with the final eleven percent spread across also-rans.

So when Abbott's plant was closed, why didn't the rest of the players jump in to steal sales? Greed is good, right? When your competitor is down, what better time to steal share, right?

Nope.

When you see a market failure this large, the market mechanisms clearly aren't working and cannot correct for a failure overnight. In the formula market, suppliers have little motivation to compete on an ongoing basis or maintain spare capacity to take advantage of a mistake by a competitor.

Lower birth rates mean the baby population is flat or declining so formula production is not a growth play for manufacturers. The product itself is highly regulated and treated with nearly the same quality control rules as pharmaceutical products which means manufacturing is not attractive for firms not already in food or pharma production sectors. Most importantly, nearly fifty percent of the formula market involves product purchased through the federal government's WIC program which requires states to operate the plan in each state, bid out ALL purchases within a state and select a SINGLE vendor to supply that state for the contract period.

This lock-in completely eliminates normal market incentives that could react to this shock and attempt to correct it. States already locked in to purchases from Abbott cannot get new contracts in place overnight to switch to another manufacturer. Even if contracts could be generated overnight, the other competitors don't have idle capacity waiting to fire up to fill the void. Even with a public failure that closes a key plant for three months, no outside firm is interested in entering the industry because of the regulatory load and compliance learning curve that must be scaled.

How Is One Plant So Critical to Supply?

The world is now twenty seven months into the COVID era and it really shouldn't be a mystery why one event at one plant can trigger such massive shocks throughout an entire industry. The formula / packaged food industry is no different than any other industry subjected to worldwide competition, intense cost pressures and substantial fixed costs. The formula for profiting in this environment is to

• minimize investment in low-growth / no-growth sectors
• protect your existing investment by minimizing competition where possible
• squeeze margins on existing capacity by minimizing inventories
• squeeze margins up and down the supply chain by outsourcing scut work or portions of the chain posing material environmental / financial / regulatory risk

The formula works perfectly for shareholders... As long as everything in the economy works EXACTLY as expected. No wars. No political shocks. No natural disasters.

When those conditions don't apply, it's a formula for failures which CANNOT be corrected in days / weeks / months by industry or government at any cost. In fact, when these conditions do not apply, the system starts CREATING black swan events like what we see now with infant formula, semiconductor chips for cars, etc. This systemic risk has been researched and diagnosed in academic circles for nearly two decades. A book published in 2005 by Barry Lynn entitled End of the Line - The Rise and Coming Fall of the Global Corporation describes the supply chain vulnerabilities posed by management practices across multiple industries and the underlying market forces that create them.

https://watchingtheherd.blogspot.com/2006/05/good-read-end-of-line.html

More of these events should be expected. They are baked into the equation.

WTH