How to calculate four firm concentration ratio
The four-firm concentration ratio is a widely used metric in economics and business to evaluate the degree of market concentration in an industry. It measures the combined market share of the four largest firms in an industry as a percentage of the total industry output or sales. A higher concentration ratio indicates greater market power held by a small number of firms, while a lower ratio represents a more competitive market with many players. In this article, we will guide you on how to calculate the four-firm concentration ratio.
Steps to Calculate the Four-Firm Concentration Ratio
1. Identify the four largest firms in the industry: Start by gathering data on the industry you are analyzing. Select the top four firms based on their output, sales, or revenues.
2. Calculate individual market shares: To calculate each firm’s market share, divide their individual output or sales by the total output or sales of the entire industry. Multiply each result by 100 to express it as a percentage.
Market Share = (Firm’s Output / Total Industry Output) x 100
3. Add up the market shares: Sum up the calculated market shares of all four firms.
4. Interpret your results: The final sum obtained in step 3 will be your four-firm concentration ratio expressed as a percentage. A higher ratio (closer to 100%) indicates an industry with high market concentration, where just four firms have significant control over the market. A lower ratio (closer to 0%) suggests that there is more competition and that no single firm dominates.
Here’s an example to help illustrate this process:
Suppose we have an industry with five firms, and their annual sales data are as follows:
Firm A: $5 million
Firm B: $4 million
Firm C: $3 million
Firm D: $2 million
Firm E: $1 million
Total industry sales: $15 million
Step 1: The top four firms in this industry are Firm A, Firm B, Firm C, and Firm D.
Step 2: Calculate the market shares:
Firm A: (5/15) x 100 = 33.33%
Firm B: (4/15) x 100 = 26.67%
Firm C: (3/15) x 100 = 20%
Firm D: (2/15) x 100 = 13.33%
Step 3: Add up the market shares:
33.33% + 26.67% + 20% + 13.33% = 93.33%
In this example, the four-firm concentration ratio is 93.33%.
Calculating the four-firm concentration ratio is a simple yet powerful tool to analyze market concentration in an industry or sector. This information helps businesses, investors, and policymakers gauge the level of competition and make informed decisions on market dynamics and potential entry or exit strategies.