What it means
The field looks at the structure of a market, the behaviour of the firms in it, and the results that follow. A market with many small sellers behaves very differently from one with a single dominant seller, even if the products are the same.
Structure covers the number of firms, how large each is, how easy it is for new firms to enter, and how different their products are. Behaviour covers pricing, advertising, investment, mergers and any cooperation between rivals.
The classic market types run from perfect competition, where many firms sell identical goods and no single firm can set the price, to monopoly, where one firm controls the market. In between sit oligopoly, with a few large firms, and monopolistic competition, with many firms selling similar but not identical goods.
A common measure of concentration is the Herfindahl-Hirschman Index, which adds up the squares of each firm's market share. Competition authorities use measures like this when reviewing mergers, and the thresholds they apply are set by the authorities themselves and change over time.
For a business, the lessons are practical. Barriers to entry such as patents, scale or brand loyalty protect profits, while easy entry pulls profits down, so strategy often involves building or defending those barriers within the law.
Game theory is a core tool in the subject, because rivals in concentrated markets must guess how others will react to a price cut or a new product. This is why airlines, telecom providers and supermarkets often seem to move prices in step.
In practice
Real-world examples.
Example
A competition authority reviews a proposed merger between two regional grocery chains. It calculates the market concentration before and after the deal and finds that the merger would push the local HHI up sharply, so it asks for stores to be sold.
Example
A software start-up studies the cloud storage market before launching. The analysis shows three large firms hold most of the market, with high set-up costs and strong brand loyalty, so the start-up targets a niche instead of competing head-on. The founders also note that customers rarely switch providers once their data is stored, which makes entry harder still.
Example
A manufacturer of industrial valves notices that its two biggest rivals always raise prices within a week of each other. The strategy team uses industrial organisation ideas to judge whether it should follow the price rise or hold its price and win share. They also check whether the rivals' costs have genuinely risen, which would justify the move.
Formula
Calculation
Herfindahl-Hirschman Index (HHI) = Sum of the squares of each firm's market share (in per cent)
Suppose four firms share a market with shares of 40%, 30%, 20% and 10%. The squares are 40 x 40 = 1,600, 30 x 30 = 900, 20 x 20 = 400 and 10 x 10 = 100. The HHI is 1,600 + 900 + 400 + 100 = 3,000. A market of ten equal firms with 10% each would score 10 x 100 = 1,000, so the first market is far more concentrated. A pure monopoly with a 100% share would score 100 x 100 = 10,000, which is the maximum possible value.Case study
Seen in the real world.
Northfield Cement is an illustrative, fictional supplier in a region where only three plants serve the market. Together with its two rivals it held shares of 50%, 30% and 20%, giving an HHI of 2,500 + 900 + 400 = 3,800.
The local construction association complained about rising prices, and the competition authority reviewed the market. It found high entry barriers, because a new cement plant costs hundreds of millions of dollars and needs years of permits. Transport costs also meant that cement from far away could not compete, so the three plants effectively shared a local market that outsiders could not easily enter.
The fictional authority did not block any firm, but it required more open pricing for large buyers and monitored the market. The illustrative lesson is that concentration alone does not prove misconduct, but it brings extra attention. Managers in such markets should keep clear records of how their prices are set and avoid any contact with rivals about pricing.
Watch out
Common mistakes.
- Assuming that a market with few firms must have high prices, when competition between the few can still be fierce.
- Defining the market too narrowly or too widely, which makes a firm look more or less dominant than it really is.
- Treating market share as the only measure of power, when barriers to entry and buyer strength matter as well.
Questions
People also ask.
What is the difference between industrial organisation and microeconomics?
Industrial organisation is a branch of microeconomics that focuses on firms, market structure and competition rather than on individual consumers or workers.
Why do regulators care about market concentration?
A highly concentrated market can give firms the power to raise prices or reduce quality, so authorities review mergers to prevent harm to customers. They also look at whether new firms could realistically enter and discipline prices.
How can a manager use industrial organisation in practice?
A manager can use it to assess how many rivals exist, how easily new ones can enter, and how competitors are likely to respond to a price or product decision.
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