Market concentration

 

What is market concentration?

The market concentration marketing metric uses unit market shares to determine the extent of dominance by the large players in the marketplace. It is a key metric to measure the intensity of competition within a market.

In the field of marketing, the different market structures of monopoly, oligopoly , perfect competition and monopolistic competition are usually discussed in marketing textbooks, with particular reference to the pricing mix. Therefore, market concentration is more commonly associated with the study of economics.

Two main formulas of market concentration

There are two main approaches to measuring market concentration,

  • A concentration index of the top 3 to 4 firms/brands in the marketplace (discussed below)
  • The Herfindahl-Hirschman Index (or HHI or H-Index)

The market concentration index

The market concentration index looks at the combined market share of the top three to four brands/firms in the marketplace. (Please note that market concentration is usually calculated using unit, rather than revenue, market shares.)

Let’s take the following example showing the unit market shares for six brands in the marketplace.

  • Brand A = 40%
  • Brand B = 30%
  • Brand C = 20%
  • Brand D = 5%
  • Brand E = 3%
  • Brand F = 2%

You should note that there are three quite successful brands and three relatively minor brands. In this case it is a relatively easy decision to determine how many brands should be included in the index – the top 3 brands should be included for this example – as the decision on 3 or more brands is based upon the brands having stronger market shares.

Therefore, the market concentration ratio would be calculated as:

  • The sum of the market share for brands A, B and C
  • Which is 40% +30% +20% = 90%.

This means that 90% of the total market is controlled by just three brands – this would be considered a highly concentrated marketplace.

Another example: With a low market concentration

Let’s now take an alternative market where there is less market concentration. Again let’s look at the market shares of the brands as follows:

  • Brand A = 12%
  • Brand B = 10%
  • Brand C = 8%
  • Brands D, E, F & G = 5% each (20% in total)
  • A further 25 brands  = 2% each (50% in total)

In this market sales are shared between 32 different brands. As you can see, it is not as clear cut as to how many brands to include in the market concentration index. Should we include just the top three brands or should we extend the index to include the top seven brands?

  • If we use the top three brands only, then the market concentration would be 12% + 10% + 8% = 30%
  • If we extend to the top seven brands, then the market concentration would be 50% (the 30% above plus another 20% from the extra four brands).

Both measures are correct and both indicate a relatively low market concentration. So the statements would be: “the top 3 brands control 30% of the market” or “the top seven brands have 50% of the market”.

For/against of this approach to measuring market concentration

The biggest advantage of this summing of market shares approach to market concentration is that it is very easy to do and is a very simple calculation. This enables another advantage – that it is very easy to communication – e.g. “the top three brands account for 70% of the market” is clear and straightforward.

The main disadvantage is that the cut-off point for the number of brands used in the calculation is subjective – as is demonstrated by the second example above. (Please note that the Herfindahl-Hirschman Index overcomes this limitation.)

Why measure market concentration?

The level of market concentration has strategic consequences for both existing and for new brands. Obviously, new brands would be less attracted to highly concentrated marketplaces that are dominated by a few firms, as there are little market opportunities. New brands instead, would prefer to target markets with a low market concentration ratio.

Market concentration ratios also give some guidance to existing brands as well. High concentration ratios suggests that the marketplace has an oligopoly structure, which generally leads to less direct competitive behavior, as it is usually not in the interests of the competitors overall. Whereas low concentration ratios suggests the advantages of product differentiation and even potential mergers and acquisitions.

For/against of this approach to measuring market concentration

The biggest advantage of this summing of the top three to four brand’s market shares approach to market concentration is that it is very easy to do and is a very simple calculation. This enables another advantage – that it is very easy to communication – e.g. “the top three brands account for 70% of the market” is clear and straightforward.

Related topics

The Herfindahl-Hirschman Index (or HHI or H-Index)

The free Excel template for market concentration

External links

There are actually many other measures of market concentration – but probably more applicable for the study of economics rather than for marketing metrics. But if you are interested, here is an academic article to review:

Academic article highlighting different approaches to market concentration