The Nature of
Industry
Chapter 7
1
Concentration Ratios


Measures of how concentrated an industry is.
1. Four Firm Concentration Ratio
 percentage
of an industry’s revenue accounted for by
the 4 largest firms

2. Herfindahl index or Herfindahl-Hirshman
Index (HI or HHI)
 sum
of the squared market share values
 (S1)2+ (S2)2+ (S3)2+...+ (Sn)2
2
Calculate market share
Tire
Sales
Makers
Top, Inc.
270
ABC, Inc. 225
Big, Inc.
180
XYZ, Inc
90
Cheap, Inc
81
Tiny, Inc.
54
Total
900
Market
Share
30%
?
20%
10%
9%
6%
100%
3
Calculate market share
Tire
Makers
Top, Inc.
ABC, Inc.
Sales
Big, Inc.
XYZ, Inc
Cheap, Inc
Tiny, Inc.
Total
180
90
81
54
900
270
225
Market
Share
30%
225/900
*100
20%
10%
9%
6%
100%
4
Calculate market share
Tire
Sales
Makers
Top, Inc.
270
ABC, Inc. 225
Big, Inc.
180
XYZ, Inc
90
Cheap, Inc
81
Tiny, Inc.
54
Total
900
Market
Share
30%
25%
20%
10%
9%
6%
100%
5
4-firm concentration ratio
Add
market
share of
top 4
firms
 4-firm CR
=?
 30+25+20
+10 = 85

Tire
Sales
Makers
Top, Inc.
270
ABC, Inc. 225
Big, Inc.
180
XYZ, Inc
90
Cheap, Inc
81
Tiny, Inc.
54
Total
900
Market
Share
30%
25%
20%
10%
9%
6%
100%
6
Another example of 4-firm
concentration ratio
Add
market
share of
top 4
firms
 4-firm CR
=?
 79+2+2+
2 = 85

Industry X Sales Market
Share
Firm A
790
79%
Firm B
20
2%
Firm C
20
2%
Firm D
20
2%
15 other
10
1%
firms each
with:
Total
1000
100%
7
Disadvantage of 4-firm
concentration ratio:

Doesn’t give extra weight to especially
large firms
8
Herfindahl Index
Tire
Sales
Market
 (S1
(S2
Makers
Share
(S3)2+...+ (Sn)2
270
30%
 (30)2+(25)2+(20)2 Top, Inc.
225
25%
+(10)2+ (9)2+(6)2 ABC, Inc.
Big, Inc.
180
20%
=
XYZ, Inc
90
10%
 900+625+400
Cheap, Inc
81
9%
+100+81+36=
Tiny, Inc.
54
6%
 2142
Total
900
100%
) 2+
)2+
9
Herfindahl Index
HI =
 6268

Industry X Sales Market
Share
Firm A
790
79%
Firm B
20
2%
Firm C
20
2%
Firm D
20
2%
15 other
10
1%
firms each
with:
Total
1000
100%
10
Herfindahl Index
Increases if the number of firms decrease
 Gives extra weight to especially large firms

11
Concentration Measures by
SIC/NAICS Code

Department of Census
http://www.census.gov/epcd/www/concentration.html
http://factfinder.census.gov/servlet/EconSectorServlet?caller=dataset&sv_name=*&_SectorId=31&ds_name=EC0700A
1&_lang=en&_ts=314058002437

Retail Bakery (311811)
 2002
4- firm CR = 4.0, HI=8.0
2007 4- firm CR = 3.7, HI=7.3

Soft Drink Manufacturing (312111)
 2002
4- firm CR = 46, HI=709
 2007 4- firm CR = 58, HI=1,095
12
Anti-trust Enforcement
Department of Justice /Federal Trade
Commission Enforcement

FTC Horizontal Merger Guidelines
http://www.usdoj.gov/atr/public/guidelines/horiz_book/hmg1.html
FTC Competition Enforcement Reports
http://www.ftc.gov/bc/caselist/index.shtml

13
DOJ/FTC Horizontal Merger Guidelines
The Guidelines describe the analytical process that the Agency will
employ in determining whether to challenge a horizontal merger. First,
the Agency assesses whether the merger would significantly increase
concentration and result in a concentrated market, properly defined and
measured. Second, the Agency assesses whether the merger, in light of
market concentration and other factors that characterize the market,
raises concern about potential adverse competitive effects. Third, the
Agency assesses whether entry would be timely, likely and sufficient
either to deter or to counteract the competitive effects of concern.
Fourth, the Agency assesses any efficiency gains that reasonably
cannot be achieved by the parties through other means. Finally the
Agency assesses whether, but for the merger, either party to the
transaction would be likely to fail, causing its assets to exit the market.
The process of assessing market concentration, potential adverse
competitive effects, entry, efficiency and failure is a tool that allows the
Agency to answer the ultimate inquiry in merger analysis: whether the
merger is likely to create or enhance market power or to facilitate its
exercise.
14
The general standards for horizontal mergers are
as follows:
a) Post-Merger HHI Below 1000. The Agency regards markets in this
region to be unconcentrated. Mergers resulting in unconcentrated
markets are unlikely to have adverse competitive effects and ordinarily
require no further analysis.
b) Post-Merger HHI Between 1000 and 1800. The Agency regards
markets in this region to be moderately concentrated. Mergers
producing an increase in the HHI of less than 100 points in moderately
concentrated markets post-merger are unlikely to have adverse
competitive consequences and ordinarily require no further analysis.
Mergers producing an increase in the HHI of more than 100 points in
moderately concentrated markets post-merger potentially raise
significant competitive concerns depending on the factors set forth in
Sections 2-5 of the Guidelines.
15
c) Post-Merger HHI Above 1800. The Agency regards markets in this
region to be highly concentrated. Mergers producing an increase in the
HHI of less than 50 points, even in highly concentrated markets postmerger, are unlikely to have adverse competitive consequences and
ordinarily require no further analysis. Mergers producing an increase in
the HHI of more than 50 points in highly concentrated markets postmerger potentially raise significant competitive concerns, depending on
the factors set forth in Sections 2-5 of the Guidelines. Where the postmerger HHI exceeds 1800, it will be presumed that mergers producing
an increase in the HHI of more than 100 points are likely to create or
enhance market power or facilitate its exercise. The presumption may
be overcome by a showing that factors set forth in Sections 2-5 of the
Guidelines make itunlikely that the merger will create or enhance
market power or facilitate its exercise, in light of market concentration
and market shares.
16
Case Study
February 20, 1986:
 Coca Cola announced intentions to
purchase Dr Pepper
 Pepsi announced intentions to buy SevenUp
 The FTC (Federal Trade Commission)
announced decision to oppose
 Pepsi withdrew; Coca Cola persisted

17
Problems with using only CR and
HI to proxy for level of competition
i) Often difficult to Define Relevant
Market

FTC Argues relevant market is Carbonated
Soft Drink (CSD) and local
 This market is highly concentrated already
and would increase with merger
18
FTC’s Ranking of Competitiveness: Concentrated
Case Study
Producers in 1985
Coca-Cola
PepsiCo
Philip Morris (7-up)
Dr. Pepper Co
R.J. Reynolds (Sunkist, Canada Dry)
Royal Crown Cola
Proctor and Gamble (Orange Crush,
Hines)
Others (supermarket brands)
Herfindahl no merger
37.42+28.92+5.72+4.62+3.02… = 2324
Share
37.4%
28.9
5.7
4.6
3.0
2.9
1.8
15.7

19
Case Study
Producers in 1985
Coca-Cola + Dr. Pepper
PepsiCo
Philip Morris (7-up)
R.J. Reynolds (Sunkist, Canada Dry)
Royal Crown Cola
Proctor and Gamble (Orange Crush,
Hines)
Others (supermarket brands)

Herfindahl with merger
422+28.92+5.72+3.02… = 2668
Share
37.4+4.6=
42.0
28.9
5.7
3.0
2.9
1.8
15.7
20
Defense (Coca Cola) Case

Market definition: all potable beverages
(HHI only 739 in all beverage
consumption)
USE CROSS-PRICE ELASTICITIES TO
HELP DETERMINE RELEVANT
MARKET
21
Problems with using only CR and HI to
proxy for level of competition
ii) Does not take into account Entry Barriers

FTC Argues that there are significant entry
barriers


Access to bottlers; economies of scale; entry
risky due to high sunk costs; limited number of
buttons and spigots
Coca-Cola argues that there are few entry
barriers

No specialized resources or talents; Kraft,
Beatrice and Borden potential entrants
22
Types of Barriers to Entry
1.
2.
Economies of Scale/ Economies of
Scope
Legal Barriers

3.
Patents, Copyrights and Franchises
Inability of potential entrants to gain
access to distribution network or
resource (ex. Alcoa and Bauxite)
23
Problems with using only CR and HI to
proxy for level of competition
iii) Cannot necessarily equate more
concentration with less competition

FTC notes that the Return on Stockholder’s
Equity for the major CSD producers is
relatively high (problem with this argument is that it does
not pertain to the consequences of the proposed merger)

Coca-Cola notes that the real price of CSDs
has declined in the last two decades
24
Problems with using only CR and HI to
proxy for level of competition
iii) Cannot necessarily equate more
concentration with less competition

Coca-Cola argues that due to the many
different product types and the inability to
monitor secret price cutting, it is difficult to
collude in the CSD industry.
 FTC argues that many different product
types and promotions would not inhibit the
ability to raise the price of CSD concentrate.
25
Problems with using only CR and HI to
proxy for level of competition (and use
this to argue against a merger)
iv) Merger may increase efficiency

Coca-Cola argues that the merger will
reduce costs due primarily to economies of
scale. These cost savings could result in
lower prices to the consumer.
26
Major Changes in CSD Industry Post-1985
1.
2.
3.
4.
7-Up and Dr. Pepper merged in late 1986 and
Cadbury-Schweppes purchased them in 1995.
Cadbury-Schweppes also acquired a number
of other brands including Canada-Dry, Sunkist,
A&W, Crush and Hires.
Technological change results in greater
economies of scale associated with bottling.
Coca-Cola and Pepsi vertically integrate by
acquiring a number of their bottling companies.
Diet CSDs’ market share has increased (from
25.9% in 1999 to 30.2% in 2004).
27
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29
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32