The term “HHI” means the Herfindahl–Hirschman Index, a commonly accepted measure of market concentration. The HHI is calculated by squaring the market share of each firm competing in the market and then summing the resulting numbers. For example, for a market consisting of four firms with shares of 30, 30, 20, and 20 percent, the HHI is 2,600 (302 + 302 + 202 + 202 = 2,600). The HHI takes into account the relative size distribution of the firms in a market. It approaches zero when a market is occupied by a large number of firms of relatively equal size and reaches its maximum of 10,000 points when a market is controlled by a single firm. The HHI increases both as the number of firms in the market decreases and as the disparity in size between those firms increases. The agencies generally consider markets in which the HHI is between 1,500 and 2,500 points to be moderately concentrated, and consider markets in which the HHI is in excess of 2,500 points to be highly concentrated. See U.S. Department of Justice & FTC, Horizontal Merger Guidelines § 5.3 (2010). Transactions that increase the HHI by more than 200 points in highly concentrated markets are presumed likely to enhance market power under the Horizontal Merger Guidelines issued by the Department of Justice and the Federal Trade Commission. See id. Updated July 31, 2018
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The concept is simple if the market share details are easily available and accurate. It explains the level of competition in the industry and the performance of the companies operating in an industry. For example, if this ratio of a company equals 100%, there is no competition in the industry, which points to the existence of a monopoly.
Concentration Ratio ExplainedConcentration ratios falling between 0% and100% provide information about the industry. If the value of the ratio is equal to 0%, perfect competition exists, and the value of 100% points to monopoly and zero competition. If the value is below 40%, then the concentration is low. It also points to monopolistic competition exhibiting many producers engaged in healthy competition by selling differentiated products. A value greater than 40% points to the medium concentration scenario pointing to the presence of oligopoly where the industry is dominated by few numbers of significant and large players. Finally, if the CR is greater than 70%, the concentration is high, and competition is very low, pointing to oligopoly or monopoly. The understanding of the concept help economists study different industries and major players in the industry and compare different companies in an industry. The economists can choose to go for three-firm, four-firm, and five-firm CR. It helps to understand the industry’s market share distribution and concentration level. Greater market concentration means larger firm size. Furthermore, a high concentration level is not always attractive since it features a monopoly or oligopoly, causing adverse effects like high barriers to entry and reducing innovation. FormulaThe concentration ratio formula is as follows:  The calculation divides the total sales contributed by the industry’s largest firms by the overall sales made by the industry. Or CRn = C1 + C2 + … + Cn
ExampleMartha wants to open a furniture company with the required capital and other resources. Still, before starting the business, she wants to know the level of competition in the furniture industry. So Martha collected the details of firms operating in the sector; five major firms have strong goodwill, brand, sales, and market share.
CRn = C1 + C2 + … + Cn CR5 = C1 + C2 + … + C5 =C1 + C2 + C3 + C4 + C5 = 16.66 + 25 + 20.83 + 12.5 + 8.33 = 83.3% Or Concentration ratio = ($100 million)/($120 million) ×100 = 83.3% The largest five firms share more than 60% market share, 83.32%, and contribute to more than half of the total industry sales. The small firms operating in the same industry contribute the rest of the market sales. This detailed information helped Martha understand the risk, competition, and growth prospects and make better business decisions. Four Firm Concentration RatioIt is the total sales of the four largest firms of any given industry compared to the entire industry sales. The four firm concentration ratio will be as follows: Or CR4 = C1 + C2 + C3 + C4 Here, C1 + C2 + C3 + C4: Sum of the percentage of market share or industry sales of the four largest firms specified. A common example is the UK supermarket or grocery industry, where the top four firms, Tesco, Sainsbury’s, Asda, and Morrisons, account for more than 60% of the supermarket industry. It explains how competitive all the four firms are and how challenging it is for new firms to enter the market. Frequently Asked Questions (FAQs)How to calculate concentration ratios? It involves calculating the ratio of sales made by the specified number of largest firms in the industry and the industry’s total sales. Another easy approach is totaling the percentage market share held by the specified number of largest firms in the industry. What is a high concentration ratio? A high concentration ratio suggests that a few companies control a considerable portion of the market, indicating strong market dominance and low competition. If the ratio is 100% or very close to it, then the presence of a monopoly is certain. Generally, if the ratio is greater than 70%, the industry’s concentration level is high and hints at oligopoly or monopoly. Why do experts study the concentration ratio in economics? The ratio helps in determining important aspects like:– Total sales contribution by the largest firms in the industry– Explains the market share held by the big firms. – Useful in evaluating the level of competition and presence of monopoly or oligopoly established in the market. |
Firm market share a 30 b 15 c 20 d 25 e 5 f 5 the four-firm concentration ratio for this industry
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