How is market concentration measured?

The term „concentration“ or „degree of concentration“ (e. concentration) originates in the theory of industrial economics and refers to how turnover in a particular market is distributed among the companies operating in that market, i.e. what their respective market shares are. . Market share is generally calculated based on a company's revenue, but the nature of some markets means that it can be estimated from other economic factors, such as units sold.

To assess market concentration, a so-called concentration ratio is calculated, which provides a good indication of how intense the competition is in the relevant market. If there are few companies, or even one with a high market share, concentration is high and competition is likely to be limited.

Concentration is most often assessed by calculating the so-called Herfindahl-Hirschman Index (i.e. HHI). This is done by squaring each company's share of the market under consideration and then summing all the resulting squares to obtain the value of the index for that market: HHI = MH1² + MH2² + MH3² + MH4² …+ MHn²

In the equation above, MH1 stands for² for the market share of the company with the highest share (number 1) to the second power, MH2² for the share of company number 2 to the power of two, etc. If all three firms operating in a given market have shares of 50%, 30% and 20% respectively, the HHI index value is 3,800 (= [50 × 50] + [30 × 30] + [20 × 20]).

The HHI index can range from near zero, when a market has many small firms, up to 10,000, which is the value when a single firm has 100% of the market share (monopoly). Markets where the HHI value is below 1,000 are generally considered to be actively competitive markets. Markets with an HHI value between 1,000 and 1,800 are considered to be moderately concentrated markets. Markets with a value between 1,800 and 2,000 are approaching being highly concentrated. 

Markets with an HHI value above 2,000 are generally considered to be highly concentrated markets. Thus, it can be said that when a few large companies operate in a market, the concentration index for that market is relatively high, reflecting rather limited competition. Conversely, the concentration index is low when only smaller companies operate in a particular market, which indicates that competition in the market is active.

Market concentration metrics are primarily used by competition authorities to assess the impact of proposed mergers on market competition. It should be noted that various other considerations are also taken into account when assessing the effects of mergers on competition, such as financial strength, barriers to market entry and potential efficiencies arising from the merger.