Download Analyzing Your Industry: Market Concentration

OCTOBER 20, 2008
Analyzing Your Industry:
Market Concentration
By Clint Reiser
Keywords
Market Concentration, Strategic Analysis , Market Intelligence, Analysis
Tools
ARC Advisory Group produces Market
Overview
Outlook Studies that provide valuable
Companies can apply the data in market studies to
information on technology markets.
evaluate the structure of a market across numerous
Companies can apply the data in market
dimensions. Market concentration is one such di-
studies to evaluate the structure of a
market across numerous dimensions.
Market concentration is one such
dimension of interest to strategic
mension
of
interest
to
strategic
planners.
Understanding the distribution of market share
among the suppliers within the market can provide
insight into the degree of competition within the
planners. Understanding the
market or segment analyzed. The two commonly
distribution of market share among the
used measures of concentration are the Herfindahl-
suppliers within the market can provide
Hirschman Index (HHI) and the Four-firm Concen-
insight into the degree of competition
tration Ratio. The Four-firm Concentration Ratio is
within the market or segment analyzed.
an easier calculation requiring much less data. The
higher the concentration ratio, the greater the mar-
ket share held by the top four firms. As a general rule, a ratio of greater
than 60 percent is considered highly concentrated and a ratio of less than 40
percent is considered an indication of a competitive market. Concentration
measures can be a useful indicator of the degree of competition in a market,
but they should be supplemented with other information to determine a
market’s structure.
Applying Market Research
ARC Advisory Group produces Market Outlook Studies that provide valuable information on technology markets. These studies provide market
size, segmentation, and growth estimates, in conjunction with qualitative
information that discusses the drivers within the market. The content and
THOUGHT LEADERS FOR MANUFACTURING & SUPPLY CHAIN
ARC Insights, Page 2
format of these studies is designed to serve as an effective planning guide
for incumbent suppliers within the market, potential market entrants, and
buyers. Suppliers can utilize the research data to enable informed investment decisions in areas such as product development expense allocation
and the evaluation of potential merger and acquisition candidates.
Market Concentration
Companies can apply the data in market studies to evaluate the structure of
a market across numerous dimensions. Market concentration is one such
dimension of interest to strategic planners. Understanding the distribution
Information on market concentration
can be used to evaluate relevant factors
such as a supplier's ability to influence
of market share among the suppliers within the
market can provide insight into the degree of
competition within the market or segment ana-
pricing, the likelihood of market
lyzed. This information can be used to evaluate
consolidation in the future, and the
relevant factors such as a supplier's ability to
attractiveness of a segment for a new
influence pricing, the likelihood of market con-
entrant.
solidation in the future, and the attractiveness of
a segment for a new entrant.
Research studies, such as ARC Market Outlook Studies, estimate the overall
size of a market and the market's segments and provide the names and
shares of leading suppliers.
This valuable information can be supple-
mented with other standard methods for evaluating the concentration of
the market. These standard concentration measures are in widespread use
by governments and economists. They are also available to the public and
can serve as a framework to compare and contrast the concentration of your
market with the concentration of similar markets.
Market Concentration Measures
The two commonly used measures of concentration are the HerfindahlHirschman Index (HHI) and the Four-firm Concentration Ratio. The HHI is
the summed square of the 50 largest firms within a market. In a competitive market, the HHI is a small number. In an uncompetitive market (one
or two firms dominating), the HHI is a large number.
The Four-firm Concentration Ratio is an easier calculation requiring much
less data. It is simply the sum of percentages of market sales attributed to
the four largest firms in the market. The higher the concentration ratio, the
greater the market share held by the top four firms. As a general rule, a
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ratio of greater than 60 percent is considered highly concentrated and a ratio of less than 40 percent is considered an indication of a competitive
market. In the United States, the census bureau publishes the 4, 8, 20, and
50 largest firm concentration ratios for numerous industries categorized by
the NAICS codes.
Four-firm Concentration Ratio in the EAM/CMMS Market
The Four-firm Concentration Ratio in 2002 for Software Publishers (NAICS
511210) in the United States was 39 percent. The ratio for this broadly defined market falls just inside 40 percent, the generally accepted boundary of
a competitive market. According to ARC research, the Four-firm ratio for
the 2006 Worldwide EAM/CMMS market is 42 percent and the North
America EAM/CMMS market is 40 percent1. This comparison indicates
that the concentration of the 2006 EAM/CMMS software market is comparable to the concentration of the broadly defined Software Publisher market
in 2002.
Market
Year
Geography
4 Firm Concentration
Software Publishers
2002
United States
39 percent
EAM/CMMS
2006
Worldwide
42 percent
EAM/CMMS
2006
North America
40 percent
EAM/CMMS Tier 3
2006
Worldwide
33 percent
PAM
2006
North America
70 percent
Example Four-firm Concentration Ratios
A strategic planner may utilize the ratio of the worldwide EAM/CMMS
market to gauge the relative attractiveness of the market segments within
the EAM/CMMS market as a whole. For example, the concentration ratio
for the EAM/CMMS market for Tier 3 customers is 33 percent, indicating a
market segment that is more fragmented than the market as a whole. This
confirms ARC's view that the Tier 3 market is less concentrated than the
market for larger customers. A company may believe, all other things remaining equal, that a less concentrated market is more attractive for new
1 ARC's definition of North America consists of the United States and Canada
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entrants than a highly concentrated market. In this situation, the concentration ratio can serve as a rough cut analysis from which further analysis on
marketing opportunities can be directed.
A concentration ratio can be used to
evaluate:
Different segments within the
same market
The same market over time
The structure of an adjacent or
complementary market
The Four-firm ratio can also be utilized to evaluate an adjacent market in which the firm in
considering entry. For example, many EAM systems integrate with Plant Asset Management
(PAM) systems that feed information on the
health of production and automation assets up to
EAM for input into predictive maintenance
plans. A large EAM/CMMS firm may be inter-
ested in determining if expanding into the PAM market would be profitable. In this situation, a quick calculation of the North American PAM
market would result in a concentration ratio of 70 percent, an indication of
a highly concentrated market. A ratio at this level is indicative of a market
where incumbents may have substantial pricing power. It may also indicate
that the market has high barriers to entry and would be most sensible to
enter through a partnership rather than a product extension.
A concentration ratio may also be used on the same market or segment over
time - a time series analysis. The analysis of a market concentration over
time can provide a gauge of the degree to which a market is consolidating.
This information may be useful for determining the maturity of a market
and for predicting the trend of the average selling price within the market.
For example, average selling price and margins may be above normal when
a market is maturing. When a market has matured, prices tend to drop and
margins decrease. However, a mature market that has experienced a high
degree of consolidation may begin to experience less competition that can
lead to higher prices and profit margins. This information can be particularly useful to large market participants attempting to gain share of a
mature market.
Last Word
Concentration measures can be a useful indicator of the degree of competition in a market, but they should be supplemented with other information
to determine a market’s structure. Concentration ratios do not take into
consideration barriers to entry into a market, relationships with suppliers
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ARC Insights, Page 5
and buyers, growth prospects, the profitability of current suppliers, or one's
own market position.
A Concentration ratio is a "rough-cut" market or industry evaluation method. The results are influenced by the scope and geographies being
analyzed. For example, the national market for heavy equipment rental is
likely to have many participants while there is likely to be only a handful of
participants in a specific local metropolitan area. Those who utilize these
ratios in their analysis should do so in conjunction with other means of evaluating the status and attractiveness of a market.
For further information or to provide feedback on this Insight, please contact your
account manager or the author at [email protected]. ARC Insights are published and copyrighted by ARC Advisory Group. The information is proprietary to
ARC and no part of it may be reproduced without prior permission from ARC.
©2008 • ARC • 3 Allied Drive • Dedham, MA 02026 USA • 781-471-1000 • ARCweb.com