Concentration Ratio

Concentration ratio (also called n-firm concentration ratio) measures the market share of top n firms in an industry. Four-firm concentration ratio which is the sum of market share of top four firms, is the most common concentration ratio. It is close to 0 in case of perfect competition and close to 1 in monopoly or oligopoly.

The degree of concentration in an industry is a source of market power, the ability of firms in a market to set their prices above their marginal cost. For example, in a monopoly where there is only one producer, a firm can charge whatever price it deems fit without worrying about any competition. Similarly, in an oligopoly where there are only a few firms, the equilibrium output is lower and the price is higher than in perfect competition.

Calculation

One way to calculate four-firm concentration ratio (4CR) is to obtain revenues of all firms in an industry, sort them in descending order, obtain the top four values, say R1, R2, R3 and R4, and divide it by the sum of revenues of all firms (RT)

$$ \text{4CR}=\frac{\text{R} _ \text{1}+\text{R} _ \text{2}+\text{R} _ \text{3}+\text{R} _ \text{4}}{\text{R} _ \text{T}} $$

Another method calculates 4CR by summing up the market share of top four firm. Market share is the ratio of a firm’s sales to the total market sales.

$$ \text{4CR}={\text{MS}} _ \text{1}+{\text{MS}} _ \text{2}+{\text{MS}} _ \text{3}+{\text{MS}} _ \text{4} $$

Concentration ratio can also be calculated using employment, output, capacity, etc.

US Census provides concentration ratios for 4, 8 and 50 largest companies for different industries in the table titled Manufacturing: Subject Series: Concentration Ratios: Share of Value of Shipments Accounted for by the 4, 8, 20, and 50 Largest Companies for Industries: 2012 which can accessed here. It also provides values for Herfindahl-Hirschman Index (HHI), a more sophisticated measure of industry concentration.

Interpretation

The four-firm concentration ratio stays in the range of 0-1. It is zero when the market share held by top four firms is negligible. It is possible only in perfect competition, a market structure in which there are so many producers that no firm can individually influence the market price.

If the four-firm concentration is 1, it means that that whole market is controlled by four or less firms. It could be just one firm (as in monopoly), two firms (as in duopoly), or three or four firms (as in oligopoly). The four-firm concentration ratio can’t help us tell whether an industry is a monopoly or an oligopoly. However, it can tell whether an industry is a loose oligopoly (when 4CR is 0.4 to 0.6) or a tight oligopoly (when 4CR is greater than 60).

Example

The following table show total revenue of different firms in industry.

A 141,000
B 225,000
C 995,000
D 1,215,000
E 5,850,000
F 222,000
G 450,000
H 210,000

Sorting the list in descending order, we see that the top four firms are E, D, C and G. The sum of their sales is $8,510,000 and the sum of sales of all firms is $9,308,000. This gives us a four-firm concentration ratio of 91.4% (=$8,510,000/$9,308,000) which is very high.

by Obaidullah Jan, ACA, CFA and last modified on

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