Market concentration
In economics, market concentration is a function of the number of firms and their respective shares of the total production in a market. Market concentration is the portion of a given market's market share that is held by a small number of businesses. To ascertain whether an industry is competitive or not, it is employed in antitrust law land economic regulation. When market concentration is high, it indicates that a few firms dominate the market and oligopoly or monopolistic competition is likely to exist. In most cases, high market concentration produces undesirable consequences such as reduced competition and higher prices.
The market concentration ratio measures the concentration of the top firms in the market, this can be through various metrics such as sales, employment numbers, active users or other relevant indicators. In theory and in practice, market concentration is closely associated with market competitiveness, and therefore is important to various antitrust agencies when considering proposed mergers and other regulatory issues. Market concentration is important in determining firm market power in setting prices and quantities.
Market concentration is affected through various forces, including barriers to entry and existing competition. Market concentration ratios also allows users to more accurately determine the type of market structure they are observing, from a perfect competitive, to a monopolistic, monopoly or oligopolistic market structure.
Market concentration is related to industrial concentration, which concerns the distribution of production within an industry, as opposed to a market. In industrial organization, market concentration may be used as a measure of competition, theorized to be positively related to the rate of profit in the industry, for example in the work of Joe S. Bain.
An alternative economic interpretation is that market concentration is a criterion that can be used to rank order various distributions of firms' shares of the total production in a market.
Factors affecting market concentration
There are various factors that affect the concentration of specific markets which include; barriers to entry, industry size and age, product differentiation and current advertising levels. There are also firm specific factors affecting market concentration, including: research and development levels, and the human capital requirements.Although fewer competitors doesn't always indicate high market concentration, it can be a strong indicator of the market structure and power allocation.
Metrics
After determining the relevant market and firms, through defining the product and geographical parameters, various metrics can be employed to determine the market concentration. This can be quantified using the SSNIP test.A simple measure of market concentration is to calculate 1/N where N is the number of firms in the market. A result of 1 would indicate a pure monopoly, and will decrease with the number of active firms in the market, and nonincreasing in the degree of symmetry between them. This measure of concentration ignores the dispersion among the firms' shares. This measure is practically useful only if a sample of firms' market shares is believed to be random, rather than determined by the firms' inherent characteristics.
Any criterion that can be used to compare or rank distributions can be used as a market concentration criterion. Examples are stochastic dominance and Gini coefficient.
Herfindahl–Hirschman Index
The Herfindahl–Hirschman index is added portion of market attentiveness. It is derived by adding the squares of all the Market participants market shares. A higher HHI indicates a higher level of market concentration. A market concentration level of less than 1000 is typically seen as low, whilst one of more than 1500 is regarded as excessive.Where is the market share of firm i, conventionally expressed as a percentage, and N is the number of firms in the relevant market.
If market shares are expressed as decimals, an HHI of 0 represents a perfectly competitive industry while an HHI index of 1 represents a monopolised industry. Regardless whether the decimal or percentage HHI is used, a higher HHI indicates higher concentration within a market.
Section 1 of the Department of Justice and the Federal Trade Commission's Horizontal Merger Guidelines is entitled "Market Definition, Measurement and Concentration" and states that the Herfindahl index is the measure of concentration that these Guidelines will use.
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Concentration ratio
The concentration ratio is a measure of how concentrated a market is. By dividing the overall market share by the sum of the market shares of the largest enterprises, it is calculated. It can be used to assess the market's strength over both the short and long haul. Generally speaking, a CR of less than 40% and a CR of more than 60% are regarded as modest and high levels of market concentration, respectively. This ratio measures the concentration of the largest firms in the formwhere N is usually between 3 and 5.
| Type of Market | CR Range | HHI Range |
| Monopoly | 1 | 6000 - 10 000 |
| Oligopoly | 0.5 - 1 | 2000 - 6000 |
| Competitive | 0 - 0.5 | 0 - 2000 |
Regulatory usage
Historical usage
Since the introduction of the Sherman Antitrust Act of 1890, in response to growing monopolies and anti-competitive firms in the 1880s, antitrust agencies regularly use market concentration as an important metric to evaluate potential violations of competition laws. Since the passing of the act, these metrics have also been used to evaluate potential mergers' effect on overall market competition and overall consumer welfare. The first major example of the Sherman Act being imposed on a company to prevent potential consumer abuse through excessive market concentration was in the 1911 court case of Standard Oil Co. of New Jersey v. United States where after determining Standard Oil was monopolising the petroleum industry, the court-ordered remedy was the breakup into 34 smaller companies.Modern usage
Modern regulatory bodies state that an increase in market concentration can inhibit innovation, and have detrimental effects on overall consumer welfare.The United States Department of Justice determined that any merger that increases the HHI by more than 200 proposes a legitimate concern to antitrust laws and consumer welfare. Therefore, when considering potential mergers, especially in horizontal integration applications, antitrust agencies will consider the whether the increase in efficiency is worth the potential decrease in consumer welfare, through increased costs or reduction in quantity produced.
Whereas the European Commission is unlikely to contest any horizontal integration, which post merger HHI is under 2000.
Modern examples of market concentration being utilised to protect consumer welfare include:
- 2014 Attempted purchase of Time Warner Cable by Comcast, was abandoned after the US DOJ threatened to file an antitrust lawsuit, citing that the HHI of the national television industry would increase by 639 points to a HHI of 2454, and feared this merger would lead to increased prices for consumers.
- Halliburton and Baker Hughes attempted 2014 merger was blocked by the US DOJ, after fears that the merger would increase costs for oil companies in 23 separate product markets, and therefore would stiffen innovation in the oil sector.
- General Electric's attempted acquisition of Honeywell in 2001, was approved in the United States, however the condition's that European Commission enforced for the approval were too impactful for General Electric, and was abandoned. This is an example on how different regulatory bodies view mergers.
Motivation for firms
Collusion
There are game theoretic models of market interaction that predict that an increase in market concentration will result in higher prices and lower consumer welfare even when collusion in the sense of cartelization is absent. Examples are Cournot oligopoly, and Bertrand oligopoly for differentiated products. Bain's original concern with market concentration was based on an intuitive relationship between high concentration and collusion which led to Bain's finding that firms in concentrated markets should be earning supra-competitive profits. Collins and Preston shared a similar view to Bain with focus on the reduced competitive impact of smaller firms upon larger firms. Demsetz held an alternative view where he found a positive relationship between the margins of specifically the largest firms within a concentrated industry and collusion as to pricing.Although theoretical models predict a strong correlation between market concentration and collusion, there is little empirical evidence linking market concentration to the level of collusion in an industry. In the scenario of a merger, some studies have also shown that the asymmetric market structure produced by a merger will negatively affect collusion despite the increased concentration of the market that occurs post-merger.