Market concentration is defined as the degree to which the top firms in an industry occupy the market share. Maunder et al (1991) describe market concentration as: ‘The concentration ratio is the percentage of all sales contributed by the leading three or five, say, firms in a market’ (ibid, pg. 561).
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Market concentration measurement is a useful tool in merger analysis. For instance, it can be used by the competition authority for screening anti-competitive mergers. This is because competition policy nowadays places more stress on firm conduct than on the firm structure, which was considered more important earlier. However, high levels of market concentration is not considered as anti-competitive, but only as a base for pinpointing mergers that need to be analysed more stringently.
Market concentration can be measured using various methods. The most popular one is by using the formula: CRk = ∑Si, I = 1…k (where Si refers to the sales revenue of the firm or the sales revenue of the subsector)
The Herfindahl Hirschman Index (HHI) and the Four Firm Concentration Ratio (CR4) are the common methods used to find market concentration.
The Herfindahl Hirschman Index method of measuring market concentration was used by the Justice Department of the US to decide on the action to be taken by the department on mergers. The value of the Herfindahl Hirschman Index can be calculated using the equation that indicates the sum of the squares of the market shares of all the firms in a market. This index is considered to be better than the CR4 because it takes into account the number of firms in the market as well as the differences in their relative size. It is observed that the value of the HHI is indirectly proportional to the number of firms in a market. In the same way, the value of the HHI is directly proportional to the degree of inequality in firm size.
The Four Firm Concentration Ratio (CR4) of measuring market concentration is the sum of the four largest firms in the market. This in itself is a weakness of this method as the number of firms included is groundless and random. Another problem is the limited amount of information it provides about the market structure in reality. The value will be similar whether the market shares of all the four firms are equal or when they are different but total the same.
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