As it relates to economic and business situations, market concentration has to do with the number of firms that account for the total production within a given industry. Sometimes referred to as industrial concentration, the idea is to identify how many firms account for the majority of the product that is produced within a given market, and whether there is room for new firms to compete within that market. One of the more common ways for assessing market concentration is the Herfindahl-Hirschman Index, or simply Herfindahl Index, which can help determine dominance in a market by one or a select few of the firms operating in that market.
With the Herfindahl-Hirschman Index, the process for determining market concentration involves looking at the performance of the top four contributing firms, and how much of the market share those four firms currently control. At the same time, this approach also considers the amount of market share held by all remaining firms in the market. In situations where the four top firms control an overwhelming percentage of the market, then the concentration is said to be high. Should the top four account for less than half the market, then the rate of concentration is said to be low.
Governments as well as businesses look closely at market concentration. Often, the goal is to prevent monopolies from forming that effectively prevent smaller firms from entering and competing in the marketplace. The idea is that as long as there is room for new businesses and for smaller businesses to expand, the rate of competition provides consumers with more options and is likely to increase spending of disposable income. This in turn helps to keep the economy healthy, creates more jobs, and in general enhances the standard of living in that nation.
A high market concentration does not necessarily mean that a market is closed. For example, three or four companies may account for the majority of production made within that market, and clearly be industry leaders. At the same time, since the dominance is not complete, that means there is the possibility for other firms to compete and possibly over time increase their market share by attracting customers of those larger firms. An example of this type of situation occurred during the latter part of the 20th century, when the deregulation of the telecommunications industry in the United States made it possible for smaller firms to offer the same range and quality of services that were once primarily offered by AT&T. While that company has remained an industry leader, other firms offering a variety of telecommunication services were able to capture an increasing amount of market share, providing both residential and business customers with more options.