3.1.5.5 - Oligopoly and market concentration

Structure and strategic conduct

An oligopoly is a market dominated by a few large suppliers. There may also be smaller fringe firms. Its distinctive behaviour is interdependence: a major firm's decisions affect rivals sufficiently that their likely reactions influence its own choice. A large supplier considering a price cut must ask whether rivals will match it and whether it will actually gain customers.

Oligopoly can therefore be described by structure—few dominant independent suppliers—or by conduct, the strategic behaviour arising from mutual dependence. Structure is easier to observe, but conduct explains why a decision differs from that of a tiny price taker. A market with several dominant firms can have vigorous price competition or relatively stable prices; the firm count alone does not identify how rivalry works.

Products can be homogeneous, as in a simplified commodity model, or differentiated by brand, quality and service. Entry barriers vary in strength. Two similarly concentrated markets can consequently have different prices, innovation and profit. A market with only two dominant suppliers is a duopoly, a particular oligopoly rather than a different endpoint from monopoly.

Define the market before counting firms: include the products and locations customers regard as alternatives. Count independently controlled businesses, not each shop or brand as a separate rival. Wholesale infrastructure and retail services may form different markets with different competitive conditions.

Calculating concentration ratios

A concentration ratio is the combined market share of the largest specified number of firms. A four-firm ratio, CR4, uses the four largest suppliers; CR3 uses three. It is a share of the defined market, not the number of firms divided by the total firm count.

Use one period, market and measure throughout: sales value, physical units or another clearly justified measure. Rank the firms first. If shares are already percentages of the same total, add the largest n shares rather than dividing again.

These are original illustrative data. The four largest individual firms sell £780 million, so CR4 is $780/1000\times100=78\%$. “Other firms combined” is not one business and must not displace D in the ranking. CR3 is 66%. Outside the top four is 22%, not four firms out of six rows.

A rise from CR4=64% to 78% is 14 percentage points, or approximately a 21.9% relative increase in the ratio, since $14/64\times100\approx21.9\%$. State which measure is intended. A higher CR4 shows more sales concentrated among the four leaders in that defined market; it does not by itself reveal which firm gained or why prices changed.

Entry barriers and differentiation

Concentration influences the scope for market power, while entry barriers and customer alternatives affect whether firms can sustain it.