Measuring the degree of actual competition in the market - Business Environment

In industrial economics the level of competition in a market is measured by concentration ratios. These measure the percentage of value added, total output or employment that is produced by a stated number of the largest firms in the industry.The common numbers are three or five. The five-firm concentration ratio measures the percentage of employment or output accounted for by the five largest firms in the industry, and was reported in the Annual Census of Production produced by the UK government until 1992. Publication of concentration ratios was discontinued in 1992.Although Table 13.10 shows only a small selection of industries, it does show that there is great variation in the degree of concentration across industries. Only one service industry is listed because of the unavailability of data relating to the services; most official data refer to manufacturing industry because of its relative historical importance. Generally services are less concentrated than manufacturing industries because of the nature of the production process and the fact that there is less scope for economies of scale.Although it is relatively easy to compare the level of concentration in particular industries over time it is more difficult to make any conclusion about the ‘average’ level of concentration (see Mini case: Concentration in this chapter). Table gives the percentage share of total employment and sales of the largest 100 private firms in the United Kingdom from 1979 to 1992. Although these are not concentration ratios as such, the data do provide an indication of how concentration has changed over time in aggregate. The change in the Standard IndustrialClassification during this period has only a small impact on the figures. Note how the level of ‘average’ concentration decreased slightly during the first part of the period, reversing the trend of the first half of this century where industrial concentration increased. The reason for the decrease is largely the process of privatization and the growth in the small-firm sector during the 1970s and 1980s. In the later part of the period concentration started to rise again, mainly due to the industrial restructuring taking place and the increased level of merger activity identified later. Again the UK government ceased publication of these figures in 1992 which makes it difficult to assess what has happened to concentration more recently. There are two industries common to Tables and sugar and tobacco and in both cases concentration has fallen between 1992 and 1998/2000, although it cannot be assumed that this is a general trend.
It is difficult to make comparisons between different countries because of this problem of ‘averaging’ concentration and because of national differences in the way in which data are collected and reported. Moreover official EU publications on industry have changed the way in which they report data, so comparisons overtime are difficult. Available evidence suggests, however, that in the 1960s concentration increased in Europe and stabilized by the 1970s before declining in the last quarter of the twentieth century, as in the United Kingdom.One of the main arguments for the creation of the Single European Market was that the bigger market would allow greater economies of scale through the growth in the size of firms. Chapter has already identified an increase in merger activity in the EU in the late 1980s in the run-up to 1992 and Table shows the change in the five-firm concentration ratios according to value added in selected sectors in the EU between 1986 and 1991. Most sectors experienced an increase in concentration levels, although there are differences between the sectors. Aerospace is one sector where concentration increased by 20 per cent, mainly due to the growth of British Aerospace and Rolls-Royce. The level of concentration in the EU has risen as a result of increased merger activity and a competition policy which is torn between promoting competition by preventing market domination and the need to establish European competitiveness by encouraging it.

Despite the difficulties in comparing concentration ratios, the general view of industrial economists is that concentration is greater in the United Kingdom than in other member states.

Reasons for high concentration
Many industries in the United Kingdom are highly concentrated and it is believed that the United Kingdom has higher concentration ratios than other large industrial countries. Why are there different market structures between industries?Referring back to Figure, the point at which the curve becomes horizontal(A in diagram) is called the minimum efficient scale of production or MES. It is the point at which all economies of scale have been reaped by the firm, and the point at which firms that wish to maximize their efficiency must operate.
The higher the MES relative to the total output of the industry, the fewer will be the number of firms operating in an industry and therefore the higher will be the level of concentration. For example, if the MES in an industry is half of the industry output, the industry could only support two firms, as smaller firms could not achieve low enough costs to compete with the large firms.As the scale of production continues to increase, average costs eventually start to rise. This is due to dis economies of scale, which are mostly attributed to managerial inefficiencies. These are the difficulties faced by management in controlling, coordinating and communicating in a large organisation.Firms in every industry will face differing average cost curves and therefore market structures will be different. In services, for example, because of the nature of the product, the scope for economies of scale is small and, accordingly, the MES is small relative to the size of the total market and the industries tend to be unconcentrated.The level of concentration in manufacturing tends to be much higher because of the nature of the production process and the scope for economies of scale.The size of the MES is not the only explanation of why there are different market structures. If it was, one might expect that the same industry would have similar levels of concentration in different countries, but this is not the case, as indicated above. The strength of the five forces will differ greatly between industries and will therefore give many different structures. Obviously government policy can influence the type of market structure, and this will differ between countries. It is also true that the significance of barriers to entry varies between countries. Empirical results from West Germany and the United Kingdom show that in both countries barriers to entry are high, but that in the United Kingdom advertising is the most important barrier, while in West Germany it is economies of scale.

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