There’s a growing concern that markets worldwide are becoming less competitive. Low competition means the leading firms hold greater market power – they can increase prices and make it challenging for smaller businesses and startups to enter the market. Another problem with rising prices and profit margins is suppressing wages. Workers and consumers suffer from high market concentration (low competition) while the big players gain wealth.
A recent US market concentration study found that over 75% of US industries have experienced a concentration increase since the late 1990s. Whether you wish to enter a particular market in the US or another location, need insights into your top competitors’ market share, or consider a specific merger, market concentration data can help you make informed decisions.
What is the market concentration?
Market concentration shows competitive intensity in a particular industry or economy. It shows the extent of production domination in a specific market by measuring the leading companies’ combined market share in that industry. That market share can refer to the percentage of total sales, the number of customers or outlets, employment statistics, and other relevant indicators.
For example, if the top five firms in an industry have more market share than the others combined, that industry is highly concentrated. That can indicate a monopoly or oligopoly (more on those in a moment), where competition is insufficient. Low concentration means the leading firms don’t have greater market power. They don’t influence the total market production in their industry, making it highly competitive.
You can use market concentration data to quantify a market structure to determine if entering that industry or economy is profitable or identify the impact of a prospective merger. It’s also a crucial indicator for calculating a location quotient to discover prospering local industries.
Location quotient data can help you determine the employment concentration in a specific region, but you’ll need firmographic data on headcount and annual revenue. The most cost-effective and time-efficient way to obtain it is to purchase it from a data provider like Coresignal.
Determining a market structure
Market concentration data helps you determine a particular market structure in an industry or economy. Understanding their characteristics will improve your decision-making.
Perfect competition
Perfect or atomistic competition indicates a structure where multiple small companies compete for market share, but none has significant market power. None influences the prices because the output is optimal. The supply equals the demand, providing allocative and productive efficiency. This market structure means all companies sell identical products or services and earn maximum profits. However, you won’t find it in the real world.
Monopolistic competition
Monopolistic competition occurs when many companies compete for market share but sell slightly different products that are not perfect substitutes. That structure doesn’t have an optimal output, and the companies can increase prices to an extent.
Monopoly
A monopoly indicates the absence of competition. One company is the sole provider of a particular product or service; it dominates the market and has the power to set high prices because no other firm can compete with it.
Oligopoly
An oligopoly refers to a structure where a tiny fraction of the market dominates the entire industry. A small number of big players hold more than 60% of the total market share. They compete or collaborate to control the market, leading to higher prices and lower wages.
How to calculate the market concentration
You can calculate market concentration using the concentration ratio or the Herfindahl-Hirschman Index (HHI).
Concentration ratio
You typically consider the top four to eight firms in an industry or economy to calculate the concentration ratio (CR), a sum of those companies’ market share percentage. The lower the ratio, the higher the competition. A 50% or lower ratio indicates low competition, while one higher than 60% shows an oligopoly. A ratio close to or equal to 100% implies a monopoly.
Herfindahl-Hirschman Index
You calculate the HHI by squaring each firm’s market share percentage and summing up the numbers to get a figure as high as 10,000. An index higher than 2,000 indicates a highly concentrated market. The HHI is more accurate because it weighs the leading companies according to their size. Here’s an example of three different markets, each with a four-firm concentration ratio of 85%:
1. Market A (low competition)
CR = 40% + 20% + 20% + 5%
HHI = 2440
2. Market B (highly competitive)
CR = 25% + 20% + 20% + 20%
HHI = 1840
3. Market C (monopoly)
CR = 75% + 5% + 3% + 2%
HHI = 5678
Conclusion
Market concentration is an imperfect indicator because the market structure and competitive intensity have an ambiguous relationship. Higher concentration doesn’t necessarily indicate a competitive decline – it can also mean competition at work. Don’t look at market concentration data alone. Consider other competitive intensity indicators, such as output, prices, profits, markups, and churn rates.
Photo credit: The photos (1, 2, 3) shown have been taken by Sergey Nivens.
