What is the 'Concentration Ratio'
The concentration ratio, in economics, is a ratio that indicates the size of firms in relation to their industry as a whole. Low concentration ratio in an industry would indicate greater competition among the firms in that industry, compared to one with a ratio nearing 100%, which would be evident in an industry characterized by a true monopoly.
BREAKING DOWN 'Concentration Ratio'
The concentration ratio indicates whether an industry is comprised of a few large firms or many small firms. The four-firm concentration ratio, which consists of the market share of the four largest firms in an industry, expressed as a percentage, is a commonly used concentration ratio. Contrary to the four-firm concentration ratio, the eight-firm concentration ratio is calculated for the market share of the eight largest firms in an industry.
Concentration Ratio Formula and Interpretation
The concentration ratio is calculated as the sum of the market share percentage held by the largest specified number of firms in an industry. The concentration ratio ranges from 0% to 100%, and an industry's concentration ratio indicates the degree of competition in the industry. A concentration ratio that ranges from 0% to 50% may indicate that the industry is perfectly competitive and is considered low concentration.
Medium concentration occurs when an industry's ratio ranges from 50% to 80%. This indicates that the industry is an oligopoly. High concentration occurs when the concentration ratio ranges from 80% to 100%, a level that indicates the industry is an oligopoly. If the concentration ratio of one company is equal to 100%, this indicates that the industry is a monopoly.
Assume that ABC Inc., XYZ Corp., GHI Inc. and JKL Corp. are the four largest companies in the biotechnology industry, and an economist aims to calculate the degree of competition. For the most recent fiscal year, ABC Inc., XYZ Corp., GHI Inc. and JKL Corp. have market shares of 10%, 15%, 26% and 33%, respectively. Consequently, the biotech industry's four-firm concentration ratio is 84%. Therefore, the ratio indicates that the biotech industry is an oligopoly. The same could be calculated for more or less than four of the top companies in the industry. The concentration ratio only indicates the competitiveness of an industry and whether an industry follows an oligopolistic market structure. The Herfindahl index, another indicator of firm size, has a fair amount of correlation to the concentration ratio and may be a better measure of market concentration.