Industry concentration is an economic measurement of how the market share in a specific industry is divided between the companies operating within it. If one or a few companies dominate the majority of a market, that industry is said to be highly concentrated. When an industry has a large number of smaller companies, all containing small percentages of the overall market share, the industry concentration is low. This information can be helpful to investors, who are most likely to seek out the companies that command a large portion of the market share in a highly concentrated industry.
Every industry has a certain hierarchy in terms of the companies at the top that dominate the market and the ones at the middle and bottom that want to get to the top. While that hierarchy may change over time, it is likely that the major players in a well-established industry will remain unchanged. Newer industries may be fragmented in the beginning before settling to a point where major players begin to gobble up large portions of the market. The study of how market share is divided up between companies in an industry is known as industry concentration.
One way in which this is studied is through the use of what's called an "industry concentration ratio." The ratio is calculated by taking a certain group of companies, usually the top four in a market, and adding up all the market share they possess. A low ratio indicates a market that is extremely fragmented. If the ratio approaches 100, it means that the market is highly concentrated and that a small number of companies dominate the majority of the market.
A company that is one of the top performers in a highly concentrated market has a distinct advantage over the companies battling it out in a fragmented market. Any company that owns high industry concentration need not be so concerned with competition and can focus its energies on increasing profit margin. By contrast, companies in a fragmented market must keep prices low in order to stay competitive, thereby damaging profits.
Investors pay attention to industry concentration figures. The companies at the top in a concentrated industry are often the target of investors because of their consistency and reliability. On the other hand, a firm in an industry that is still relatively young may have greater potential. Stock for such a firm can be had at a low price, but it has great potential if both the industry and the firm rise to greater heights.