Industrial Concentration

“ Industrial concentration” refers to a structural characteristic of the business sector. It is the degree to which production in an industry—or in the economy as a whole—is dominated by a few large firms. Once assumed to be a symptom of “market failure,” concentration is, for the most part, seen nowadays as an indicator of superior economic performance. In the early 1970s, Yale Brozen, a key contributor to the new thinking, called the profession’s about-face on this issue “a revolution in economics.” Industrial concentration remains a matter of public policy concern even so.

The Measurement of Industrial Concentration

Industrial concentration was traditionally summarized by the concentration ratio, which simply adds the market shares of an industry’s four, eight, twenty, or fifty largest companies. In 1982, when new federal merger guidelines were issued, the Herfindahl-Hirschman Index (HHI) became the standard measure of industrial concentration. Suppose that an industry contains ten firms that individually account for 25, 15, 12, 10, 10, 8, 7, 5, 5, and 3 percent of total sales. The four-firm concentration ratio for this industry—the most widely used number—is 25 + 15 + 12 + 10 = 62, meaning that the top four firms account for 62 percent of the industry’s sales. The HHI, by contrast, is calculated by summing the squared market shares of all of the firms in the industry: 252 + 152 + 122 + 102 + 102 + 82 + 72 + 52 + 52 + 32 = 1,366. The HHI has two distinct advantages over the concentration ratio. It uses INFORMATION about the relative sizes of all of an industry’s members, not just some arbitrary subset of the leading companies, and it weights the market shares of the largest enterprises more heavily.

In general, the fewer the firms and the more unequal the distribution of market shares among them, the larger the HHI. Two four-firm industries, one containing equalsized firms each accounting for 25 percent of total sales, the other with market shares of 97, 1,...