Market Concentration

It is possible to determine what type of market we are observing by the number of firms which are active in the. Simply counting the number of firms which are competing in a market does not tell us anything about the extent to which certain firms are able to exert influence over the market. It is possible that there are a large number of firms active in a market. This is true of the holiday market where there are a large number of tour operators ranging from multinational companies such as TUI to small independent tour operators specialising in escorted tours to Patagonia (if you don’t know where Patagonia is, have a look at an Atlas). What is of much greater significance is not the number of firms in the market but the influence (market power) which the largest firms in the market are able to exert. Therefore, if there are hundreds of firms operating in a market but that market is dominated by two firms who control 90% of the market’s sales a different picture emerges.   Whereas a large number of firms suggests perfect or monopolistic competition, the existence of two firms controlling the majority of the market indicates that the two firms are operating more like oligopolists.

Concentration ratios are often used to measure the degree of competition or monopoly power in a market. The simplest measure of industrial concentration involves adding together the market share of the largest 2, 3 or 5 firms. This gives what is known as the ‘2-firm,’ ‘3-firm’ or ‘5-firm concentration ratio.’

Three firm concentration ratio =

     Market share of the largest 3 firms

Market share of all the firms in the market

Figures for market concentration in the foreign package holiday market vary. Part of this variation depends upon the type of holiday which is included in the data. If cruises are excluded from the calculation then the three firm concentration ratio is around 0.5. If the definition of foreign package holidays is narrowed down to the traditional sun, sea and sand type of holiday then the three firm concentration ratio is around 0.65. All of the leading three firms are vertically integrated (they have their own travel agents, tour operator, and airlines).