Reviewed by Sep 30, 2020| Updated on
Concentration ratio indicates the level of competition between firms comprised in an industry. It is the ratio of the size of the firms to the entire industry. A high concentration ratio closer to 100% indicates the existence of a monopoly in an industry or lack of competition to such firms. A lower concentration ratio indicates higher competition among the firms in the industry.
The concentration of firms is different among different industries. It may be dependent on the nature of the product, the limited availability of the product, or certain country or countries having the majority of the natural resources required for the product.
The concentration ratio facilitates understanding the nature of the industry. The industry may be dominated by a few firms, or there may be wide competition in the industry.
An example for an industry dominated by a few firms is the telecom industry in India. On the other hand, one can find wide competition and variety of products in the FMCG industry.
The most common concentration ratio is the four-firm concentration ratio, where four large firms in the industry dominate the market. There is another ratio, the eight-firm concentration ratio where the industry is dominated by eight large firms.
The concentration ratio can range from 0% to 100%. In an industry with a concentration ratio between 0% and 50%, the industry is perfectly competitive. In case the concentration ratio is 100%, there exists a monopoly.
In an industry where the concentration ratio is between 51 and 100%, there are signs of an oligopoly in the industry. An oligopoly consists of few firms in an industry which act together or change prices together. Typically in an oligopoly, the action of one firm is followed by the others in the industry.
The concentration ratio is an indicator of the competition in an industry. It also helps us understand the market structure of an industry. There are other measures used to calculate the concentration of firms, competitiveness, or behaviour of an industry. However, the concentration ratio is the most common measure.