Market concentration

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In economics, market concentration is a function of the number of firms and their respective shares of the total production (alternatively, total capacity or total reserves) in a market. 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. [1] 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. [2] Market concentration is important in determining firm market power in setting prices and quantities.

Contents

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. [3]

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 (alternatively, total capacity or total reserves) in a market.

Factors affecting Market Concentration

The 2020 Australian Telecommunications firms market share: an example of a highly concentrated market with an estimated HHI of 3034.

Telstra (37%)
Optus (30%)
Vodafone (27%)
Other (6%)

There are various factors that affect the concentration of specific markets including which include; barriers to entry(high start-up costs, high economies of scale, brand loyalty), 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. [4]

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 (e.g. probability distribution, frequency distribution or size distribution) can be used as a market concentration criterion. Examples are stochastic dominance and Gini coefficient.

Herfindahl–Hirschman Index

The most commonly used market concentration measures is the Herfindahl–Hirschman Index (HHI or H).

${\displaystyle H=\sum _{i=1}^{N}s_{i}^{2}}$

Where ${\displaystyle s_{i}}$ is the market share of firm i, and N is the number of firms in the relevant market. If using decimals, the HHI index can range from 1/N to 1. However when using percentages, a HHI can range from 1 to 10000. In most markets, a HHI below 1500 indicates a market with low concentration, a HHI of 5000 indicates a duopoly and a HHI of 10000 indicates a fully monopolised market. [5]

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. [6] The Department of Justice considers.

Concentration Ratio

Another common measure is the concentration ratio (CR). [7] This ratio simply measures the concentration of the largest firms in the form

${\displaystyle CR_{n}=C_{1}+C_{2}+C_{n}}$

where N is usually between 3 and 5. Although CR can provide a quick insight into the overall market concentration, it is limited in providing an accurate representation of industry competition, as this ratio does not provide a measure for the concentration within the top n, as a merger between two firms would not increase the overall CR, but would increase overall market concentration using other measures.

As a rule of thumb, when using n=5 anything over 0.6 or 60% is considered an oligopoly, whereas when N=5, anything under 0.5 or 50% can be considered competitive and lowly concentrated. [8]

Relationship between Market Structure and Market Concentration Metrics
Type of MarketCR RangeHHHI Range
Monopoly16000 - 10 000 (Depending on Region)
Oligopoly0.5-12000-6000 (Depending on Region)
Monopolistic0-0.50 - 2000 (Depending on Region)
Competitive0-0.50 - 2000 (Depending on Region)

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. [9] 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. [10]

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 . [11] 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. [12]

Whereas the European Commission is unlikely to contest any horizontal integration, which post merger HHI is under 2000 (except in special circumstances). [13]

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. [14]
• Halliburton and Baker Hughes (at the time the 2nd and 3rd largest oilfield services companies, respectively) 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. [15]
• 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. [16] This is an example on how different regulatory bodies view mergers.

Motivation for Firms

Efficiency

As an economic tool market concentration is useful because it reflects the degree of competition in the market. Understanding the market concentration is important for firms when deciding their marketing strategy. As well, empirical evidence shows that there exists an inverse relationship between market concentration and efficiency, such that firms display an increase in efficiency when their relevant market concentration decreases. [17]

Collusion

There are game theoretic models of market interaction (e.g. among oligopolists) 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 (i.e. explicit collusion) is absent. Examples are Cournot oligopoly , and Bertrand oligopoly for differentiated products . Historically, Bain's (1956) original concern with market concentration was based on an intuitive relationship between high concentration and collusion. [3]

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. [18]

Alternative Metrics

Although, not as common as the Herfindahl–Hirschman Index or Concentration Ratio metrics, various alternative measures of market concentration have been used.

(a) The Rosenbluth (1961) index (also Hall and Tideman, 1967):

${\displaystyle R={\frac {1}{2\sum is_{i}-1}}}$ where symbol i indicates the firm's rank position.
The Rosenbluth index assigns more weight to smaller competitors when there are more firms present in the marketplace, and is sensitive to the amount of competitors in the market, even if there is a small amount of large firms dominating. Its coefficients and ranking are similar to results produced through the use of the Herfindahl-Hirschman Index. [19]

(b) Comprehensive concentration index (Horwath 1970):

${\displaystyle CCI=s_{1}+\sum _{i=2}^{N}s_{i}^{2}(2-s_{i})}$
Where s1 is the share of the largest firm. The index is similar to ${\displaystyle 2{\text{H}}-\sum s_{i}^{3}}$ except that greater weight is assigned to the share of the largest firm. When compared to the HHI index, it does present some advantages, such as giving more weight to the quantity of small firms, however the arbitrary choice to only include the absolute value of one firm has led to criticism over its accuracy and usefulness. [19]

(d) The Linda index (1976)

${\displaystyle L={\frac {1}{N(N-1)}}\sum _{i=1}^{N-1}Q_{i}\left[{\frac {n-i}{i}}\right]\left\vert {\frac {CR_{i}}{CR_{n}-CR_{i}}}\right\vert }$
where Qi is the ratio between the average share of the first ${\displaystyle i}$ firms and the average share of the remaining ${\displaystyle N-i}$ firms and ${\displaystyle CR_{i}}$ is the concentration coefficient for the first ${\displaystyle i}$ firms. Although it doesnt capture the peripheral firms like the HHI formula, it works to capture the "core" of the market, and masure the degree of inequality between the size variable accounted for by various sib-samples of firms. This index, does assume pre-calculation on the users' behalf to determine the relevant value of ${\displaystyle CR_{i}}$ [20] However, there is little empirical evidence of regulatory usage of the Linda Index.

(e) The U Index (Davies, 1980):

${\displaystyle U=I^{*a}N^{-1}}$ where ${\displaystyle I^{*}}$ is an accepted measure of inequality (in practice the coefficient of variation is suggested), ${\displaystyle a}$ is a constant or a parameter (to be estimated empirically) and N is the number of firms. Davies (1979) suggests that a concentration index should in general depend on both N and the inequality of firms' shares.

The "number of effective competitors" is the inverse of the Herfindahl index.

Terrence Kavyu Muthoka defines distribution just as functionals in the Swartz space which is the space of functions with compact support and with all derivatives existing. The Media:Dirac_Distribution or the Dirac function is a good example .

Related Research Articles

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In an economic context, concentration ratios are used to quantify market concentration and are based on companies' market shares in a given industry. Market share can be defined as a firm's proportion of total sales in an industry, a firm's market capitalisation as a percentage of total industry market capitalisation or any other metric which conveys the size and dominance of a company relative to its competitors. 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, where n = 5, CR5 defines the combined market share of the five largest firms in an industry.

The Herfindahl index is a measure of the size of firms in relation to the industry they are in and an indicator of the amount of competition among them. Named after economists Orris C. Herfindahl and Albert O. Hirschman, it is an economic concept widely applied in competition law, antitrust and also technology management. HHI is calculated by squaring the market share of each competing firm in the industry and then summing the resulting numbers,(sometimes limited to the 50 largest firms), where the market shares are expressed as fractions or points. The result is proportional to the average market share, weighted by market share. As such, it can range from 0 to 1.0, moving from a huge number of very small firms to a single monopolistic producer. Increases in the Herfindahl index generally indicate a decrease in competition and an increase of market power, whereas decreases indicate the opposite. Alternatively, if whole percentages are used, the index ranges from 0 to 10,000 "points". For example, an index of .25 is the same as 2,500 points.

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