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. Similar 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. The three-firm and five-firm are two more concentration ratios that can be used.

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.

A rule of thumb is that an oligopoly exists when the top five firms in the market account for more than 60% of total market sales. If the concentration ratio of one company is equal to 100%, this indicates that the industry is a monopoly.

Example Calculation

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.

Herfindahl-Herschman Index

The Herfindahl-Herschman Index (HHI) is an alternative indicator of firm size, calculated by squaring the percentage share (stated as a whole number) of each firm in an industry, then summing these squared market shares to derive a HHI. The HHI has a fair amount of correlation to the concentration ratio and may be a better measure of market concentration.

RELATED TERMS
  1. Accounting Ratio

    Accounting ratios, also known as financial ratios, are used to ...
  2. Combined Ratio

    Combined ratio is a measure of profitability used by an insurance ...
  3. Capitalization Ratios

    Capitalization ratios are indicators that measure the proportion ...
  4. Price/Earnings To Growth - PEG ...

    Price/Earnings to Growth (PEG) is a stock's price to earnings ...
  5. Cash Ratio

    The cash ratio is the ratio of a company's total cash and cash ...
  6. Bond Ratio

    A bond ratio is a financial ratio that expresses the leverage ...
Related Articles
  1. Investing

    Is the Equity Market Overly Concentrated?

    Explore the potential impact concentration could have on the valuations of leading companies.
  2. Investing

    Financial Ratios to Spot Companies Headed for Bankruptcy

    Obtain information about specific financial ratios investors should monitor to get early warnings about companies potentially headed for bankruptcy.
  3. Investing

    Payout Ratio vs. Retention Ratio: When to Use Which

    The payback ratio and retention ratio collect different information and are useful in different situations.
  4. Investing

    6 Basic Financial Ratios And What They Reveal

    These formulas can help you pick better stocks for your portfolio once you learn how to use them.
  5. Investing

    Why do Debt to Equity Ratios Vary From Industry to Industry?

    Obtain a better understanding of the debt/equity ratio, and learn why this fundamental financial metric varies significantly between industries.
  6. Investing

    Useful Balance Sheet Metrics

    These metrics can help you better understand the information found on balance sheets.
  7. Investing

    Wal-Mart's 5 Key Financial Ratios (WMT)

    Identify the five key financial ratios that fundamental analysts use to evaluate Wal-Mart's (WMT) financial position to determine if it is a good buy.
  8. Investing

    Useful metrics for evaluating bank stocks

    Learn which metrics are most useful to evaluate companies in the banking sector and the issues when comparing them across the various banks.
  9. Investing

    PEG Ratio Nails Down Value Stocks

    Learn how this simple calculation can help you determine a stock's earnings potential.
RELATED FAQS
  1. What is the difference between efficiency ratios and profitability ratios?

    Learn about efficiency and profitability ratios, what these ratios measure and the main difference between efficiency and ... Read Answer >>
  2. Why do shareholders need financial statements?

    Discover the importance of a company's financial statements for stock shareholders in evaluating their equity investment ... Read Answer >>
  3. If a company has a high debt to capital ratio, what else should I look at before ...

    Learn about some of the financial leverage and profitability ratios that investors can analyze to supplement examining the ... Read Answer >>
  4. What do efficiency ratios measure?

    Learn about efficiency ratios, what they measure, how to calculate commonly used efficiency ratios and how to interpret these ... Read Answer >>
Trading Center