In economics, concentration ratios are used to quantify market concentration and are based on companies' market shares in a given industry.
A concentration ratio (CR) is the sum of the percentage market shares of (a pre-specified number of) the largest firms in an industry. An n-firm concentration ratio is a common measure of market structure and shows the combined market share of the n largest firms in the market. For example, if n = 5, CR5 defines the combined market share of the five largest firms in an industry.
Competition economists and competition authorities typically employ concentration ratios (CRn) and the Herfindahl-Hirschman Index (HHI) as measures of market concentration.
Calculation
The concentration ratio is calculated as follows: [1]
where defines the market share of the th largest firm in an industry as a percentage of total industry market share, and defines the number of firms included in the concentration ratio calculation.
The and concentration ratios are commonly used. Concentration ratios show the extent of largest firms' market shares in a given industry. Specifically, a concentration ratio close to 0% denotes a low concentration industry, and a concentration ratio near 100% shows that an industry has high concentration.
Concentration levels
Concentration ratios range from 0%–100%. Concentration levels are explained as follows: [2]
| Concentration Level | Concentration Ratio | Explanation |
|---|---|---|
| Perfect competition | Perfect competition exists where an industry's concentration ratio is CRn = n/N, where N is the number of firms in the industry. That is, all firms have an equal market share. | |
| Low concentration | – 40% | A concentration ratio of close to 0% implies perfect competition at the least. This is only possible in an industry where there is a very large number of firms. |
| Medium concentration | 40% – 70% | An industry in this range is likely an oligopoly. An oligopoly describes a market structure which is dominated by a small number of firms each with significant market shares. |
| High concentration | 70% – 100% | This category ranges from an oligopoly to a monopoly. |
Benefits and shortfalls
Concentration ratios can readily be calculated from industry data, but they are a simplistic, single parameter statistic. They can be used to quantify market concentration in a given industry in a relevant and succinct manner, but do not capture all available information about the distribution of market shares. In particular, the definition of the concentration ratio does not use the market shares of all the firms in the industry and does not account for the distribution of firm size. Also, it does not provide much detail about competitiveness of an industry.[1]
The following example exposes the aforementioned shortfalls of the concentration ratio.
Example
The table below shows the market shares of the largest firms in two different industries (Industry A and Industry B). Aside from the tabulated market shares for Industry A and Industry B, both industries are the same in terms of the number of firms operating in the industry and their respective market shares. In this example, in both cases, all other firms have a share of less than 10%.
| Firm | Industry A | Industry B |
|---|---|---|
| Firm 1 | 20% | 35% |
| Firm 2 | 20% | 25% |
| Firm 3 | 20% | 10% |
| Firm 4 | 20% | 10% |
It is evident from these figures that Industry B is more concentrated than Industry A, since the market share is distributed more heavily towards the more dominant firms. However, Industry A and Industry B both have CR4 ratios of 80%. This shows that the CR ratio does not fully take into account the distribution of market share amongst the most dominant firms.
References
- 1 2 Besanko, David (1 July 2017). Economics of Strategy. Wiley. p. 162. ISBN 978-1-119-04231-0.
- ↑ "IBIS World". Archived from the original on 8 December 2018. Retrieved 21 July 2017.