Business

How to Measure Market Concentration

Definition

Market concentration is the role of the number of companies and their individual shares of the total production in a particular market. In addition, market concentration is usually referred to as seller concentration or industry concentration.

Market concentration is associated with industrial density, which describes the distribution of production in a particular market. Market concentration can be used in an industrial organization to determine the level of competition, hypothesized to be related to the industry’s rate of profit.

Market concentration is mostly used in cases when smaller businesses account for a more significant percentage of the entire industry. It determines the level of the dominion of sales by one or more businesses in the specific industry. The concentration ratio determines a market concentration ratio.

Market concentration ratio

The market concentration ratio is used to determine the integrated market share of the most dominant businesses in the market. This could be a number of people using the company’s services, sales, number of outlets and employment statistics amongst others. The value of the top businesses or top ‘X’ businesses can be at least three and a maximum of five. If the top businesses continue dominating and gaining the market share, then it can be said that the market has become extremely concentrated.

However, before you understand market concentration, you must understand what ‘concentration’ is. Concentration in a market can be described as the level at which smaller number of businesses contribute to the total market production. If the concentration is low, it means that the companies dominating the market are not controlling the market production and the industry is thought to be extremely competitive.

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If the concentration is high, on the other hand, it means that the dominant businesses control the production of goods and services offered to the market, and thus, the industry is considered to be monopolistic or oligopolistic.

The Herfindahl-Hirschman Index (HHI) is the standard measure used when calculating the market concentration. The calculation requires the addition of the square root of the portion or percentage market share of every individual business in the industry.

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