Market concentration is the measurement of businesses’ market shares within an industry. While its primary purpose may be identifying competitive industries, it also has far reaching effects that affect prices and quality.
Multiple factors contribute to high market concentration. These include monopolies, mergers and acquisitions, barriers to entry and brand loyalty among existing businesses; regulatory hurdles or high startup costs may also play a part in creating this environment of high concentration in markets.
Increased profits
Market concentration has an impactful effect on competition and profits by determining which companies dominate an industry. When there are only a handful of major players dominating an industry, competition between businesses becomes fiercer; more customers vie for customers’ attention from multiple vendors that provide competitive offers; ultimately leading them to maximize profit potential for maximum earnings potential.
Concentrated industries can become highly concentrated over time, and dominant players may gain pricing power. As a result, higher prices may limit consumer choices or even lead to anticompetitive actions like price fixing and collusion between players.
As a result, concentration has increased across many sectors as evidenced by the Herfindahl-Hirschman Index (HHI). While HHI may indicate increased prices, its rise may also be affected by barriers to entry such as high startup costs or customer loyalty to established brands; making it hard to pinpoint exactly why concentration has increased.
Less competition
The Herfindahl-Hirschman Index (HHI) is an industry-level measurement used by government regulators to help them assess whether an industry provides healthy competition or is heading in the direction of monopoly. The index uses a simple calculation, taking the sum of squares of market shares across an entire industry as input data; however, due to its simplistic nature it has its limitations.
Concentration’s primary drawback is competition loss. No matter whether national- or industry-level measures are used, concentration appears to be on the rise across most industries. The reasons may range from higher entry barriers, more predatory mergers and decreased dynamism among small firms as a potential explanation.
Concentration can also stifle innovation. For instance, dominant businesses that can limit competition through financial muscle may use it to increase prices or restrict output – both of which limit innovation and consumer choice. Furthermore, high barriers to entry may deter newcomers by demanding upfront investments with complex regulatory compliance requirements for them to enter an industry.
Less innovation
The Herfindahl-Hirschman Index, commonly referred to as HHI, is a popular way to evaluate industry concentration and assess whether an industry offers healthy competition or leans toward monopoly. Federal regulators frequently utilize this index when reviewing corporate mergers to ensure their approval will not foster unhealthy market dominance and hinder innovation.
HHI measures market share as the squared market share of the top 50 companies within an industry and can be calculated quickly and easily. Unfortunately, its ease of calculation doesn’t take into account all the subtleties and complexities present in certain markets.
As there is mounting evidence that increased market concentration can limit innovation and lower wages, it becomes harder for entrepreneurs to innovate and earn higher wages. While pinpointing exactly why this phenomenon occurs can be tricky, likely causes include increasing scale effects such as network effects or anticompetitive mergers that raise profit margins while diminishing start-up rates are all likely contributors. Business leaders should factor market concentration into their evaluation of competitive landscapes and strategy development processes.
Decreased consumer choice
Market concentration can present consumers with numerous negative impacts, including higher prices and limited product choice. One method used to gauge market concentration is through the Herfindahl-Hirschman Index (HHI), calculated from all firm shares percentages squared; HHI values above 1.0 are generally considered high while those below 0.5 should be seen as being low.
Economic theory dictates that concentrated markets are more conducive to monopolistic practices and profits, leading to higher profits at reduced consumer welfare. Yet recent studies conducted via direct comparison of output prices with profit concentration have demonstrated that price concentration measures do not always correlate to actual profits made.
Market concentration has long been thought of as an inhibitor of innovation – one of the key tenets of business success. By understanding both its advantages and drawbacks, businesses can make more resilient strategic plans while mitigating risk through contingency planning – something especially helpful in highly concentrated industries such as technology and finance.