Measuring Market Power in an Industry
Concentration Ratio
A commonly used measure of market power is the concentration ratio. It is defined as follows:
The m-firm concentration ratio is the market share of the largest m firms in an industry.
It is common to report the 4-firm concentration ratio (the market share of the 4 largest firms) and the 8-firm concentration ratio (the market share of the 8 largest firms).
In general, the greater the 4-firm ratio, the greater the oligopoly power of the 4 largest firms. Hence the more concerned one must be about abuse of oligopoly power, and anti-competitive behavior such as collusion amongst the 4 firms and the creation of barriers to entry. Thus the purpose of computing the concentration ratio is to locate industry’s that may potentially have anti-competitive behavior.
The tables below provide some examples of concentration ratios related to tourism.
Examples of Concentration Ratios in Other Countries
TABLE 1Air Passenger Transportation Concentration Ratios in U.S.
All firms / 2002 / 100.0
4 largest firms / 2002 / 33.6
8 largest firms / 2002 / 51.5
20 largest firms / 2002 / 73.7
50 largest firms / 2002 / 90.3
TABLE 2
Hotel Concentration Ratio in U.S.
All firms / 2002 / 100.0
4 largest firms / 2002 / 22.4
8 largest firms / 2002 / 28.8
20 largest firms / 2002 / 36.3
50 largest firms / 2002 / 43.8
TABLE 3
4 Firm Concentration Ratio in Tourism Sector in Thailand
Hotels / 2005 / 11.00
Car Rental / 2005 / 40.00
Hired Shuttle Vehicles / 2005 / 72.00
Tour Guide Services / 2005 / 74.00
Tables 1 and 2 provide the 4, 8, 20, and 50 firm concentration ratios in the U.S. in 2002 for the air passenger and hotel industries. In Table 1, the air passenger industry, we see that 33% of the market is controlled by the four largest firms, and the eight largest firms control about 50% of the market. While that indicates air passenger is an oligopoly, the fact that 50 firms exists suggests this is not significant oligopoly power. In Table 2, we see the 4-firm and 8-firm concentration ratios in the hotel industry are not as large, suggesting a much more competitive environment.
Table 3 provides the 4-firm concentration ratio for various sectors of the tourism industry in Thailand. It is clear that hotels is a competitive industry, and car rentals may be fairly competitive, though clearly an oligopoly. However, both Hired Shuttle Vehicles (i.e. vehicles with drivers) and Tour Guide Services are very significant oligopolies, with over 70% of the market controlled by the four largest firms.
What the above tables indicate is that there is a wide range of industry structure in tourism both around the world, and inside a given country.
Criticism of Concentration Ratio
There are two significant criticisms regarding the use of concentration ratios.
1. The Definition of the Market
As with a monopoly it is not always clear how to define a market for the purpose of determining the concentration ratio. Ideally, we want the market to include all firms in competition with each other. If we define the market too narrowly, we may overstate the degree of oligopoly power in computing the concentration ratio. For example, consider the market for hotels. If we define the market as Nizwa, then the four firm concentration ratio will be 100% since there are only four firms. This would appear to be an industry of significant oligopoly power. However, since tourists can travel to Nizwa from Muscat and other places, this is probably not the correct definition of the market. If we include all hotels in Muscat and surrounding areas in the market area, the four firm concentration ratio will be much lower, indicating the hotel industry is competitive. Hence, one must be careful in defining the market when using and interpreting concentration ratios.
2. Contestable Markets
Another problem with concentration ratios is that it assumes the number of firms, with large market share, is all one needs to know to determine market power. At first this probably seems correct, but the theory of contestable markets demonstrates it is not correct.
The theory of contestable market argues that even if the number of firms is small, but there is significant threat of new entrants the existing firms will behave competitively. As an example, suppose a firm is a natural monopoly; thatis, there is only enough business for one firm to be profitable. However, the industry has no barriers to entry. This implies that if the natural monopoly power tried to exert market power and behave like a monopoly a new firm could enter the market and take away its business. This threat of competition is enough to make the natural monopoly behave competitively.
Clearly there must be no barriers to entry for the threat of new entrants to exist. Moreover, the start-up costs should be small. So it is not the case that all oligopolies are in contestable markets, but it does demonstrate that the number of firms with large market share is not enough to say there is significant oligopoly power. We must also know whether the market is contestable. Only if the concentration ratio is high and the market is not contestable can we say there is significant oligopoly power.