Large corporations and businesses have historically wielded very large influence on many economies and the macroeconomic cycle as a whole. But how can single entities be so influential on the scope of entire economies? The answer to this question begins with understanding the sheer scale of industry leaders, and how maintaining control over an entire sector of the economy leads directly to swaying economic performance, as single decisions and varying years of performance can either shatter or significantly grow economies.
A reliable measure to track the influence of a large corporation on the market is market concentration. Market concentration refers to how much a select few companies or firms dominate a particular sector of a market, in other words, whether a sector’s total production is distributed between various bodies or concentrated on few. Here, a high market concentration exists when there are a select few dominating bodies, whereas a distributed production is a lower market concentration.
The HHI Index
A leading metric in calculating specific values of market concentration is the Herfindahl-Hirschman Index (HHI), which measures the combined market shares of top companies in reference to the total shares in the sector. HHI is calculated by taking the market share of each company (considering the company as a percentage of the industry) in consideration, squaring, then adding together. If we were measuring HHI in an industry with one firm, the market concentration would be 100% and have an HHI of 10,000, indicating a monopoly in this industry. Generally, an HHI above 2,500 is considered a heavily concentrated market, and tends to have large firms leading the industry.
Let’s analyze an example. Say, in a hypothetical scenario, Samsung and Apple were the only mobile phone producers in the market. This means each company has a 50% market share, and will therefore have an HHI of (502+502) = 2500 + 2500 = 5000, indicating that this smartphone market is heavily concentrated. Let’s look at an opposite example. Suppose in the snack manufacturing industry there are ten leading companies, each having a 10% market share. The HHI of this market would then be calculated as (102*10) = 100*10 = 1000. Based on our previously defined standards for HHI, we can say that it is moderately concentrated, and is more competitive than the previously described smartphone market.
High Concentration Leaders
But why is market concentration so relevant to the state of a particular market? Well, we can begin by analyzing a metric known as pricing power; which refers to how the actions of a particularly large firm or corporation can influence the price of a particular good or service in large magnitudes. A company has substantial pricing power if minor actions taken by the company have a large effect on the price of a good, and vice versa. If a small number of firms controls a majority market share, they are capable of increasing prices even in a competitive market.
Along with the rise in prices that these major corporations bring, these corporations force most consumers to comply with their changes because of a lack of other options. Similarly, in concentrated markets, dominating corporations can easily interfere with the supply and demand of a good or service – as a result of the hold on their particular industry – to control the price of that good. If a market leader significantly decreases their output of a particular service, they are able to drive up prices, whereas increasing their output, they can drop the price of the service and drive their competitors out of the market.
This theory of decreasing prices to force competitors away is known as predatory pricing, and is common in single firm-dominant markets. If market leaders in high market concentration environments choose to take major stakes in smaller industry rivals, or practice predatory pricing, the industry will have much lower competition, and will slow down innovation within the industry, decrease quality, and lower consumer options as a result. This can also lead to consumer burden, where certain market scenarios will encourage firms to raise prices significantly, and force consumers into complying with unjust raises in prices without better options.
This brings us to a macroeconomic concept known as monopoly. In rare cases, single firms will be the majority leader of a particular market, and will have virtually total control over the future of the market in question. A monopoly exists when there is a sole producer of a good or service within an industry, and therefore operates on a significantly large market share. Industry leaders will shift into monopoly when they create “barriers” that prevent new companies from entering the market. When companies have significant brand recognition, control of resources, legal restrictions, or empowering financial resources, they are effectively preventing other firms from gaining a substantial market share. With a grip on the market and the ability to drive out competitors, monopolies can use their market share, as well as supply and demand, to change industry prices, and force consumer burden. In monopoly companies, there is less pressure to meet industry standards, and each company can look for optimal revenue compared to focusing on consumer satisfaction, innovation, and quality control.
But how can unfair action and market manipulation be controlled? In cases where market behavior has reached a stage where intervention is necessary, government market regulators will step in. This is where the HHI index can come into play, where an alarming HHI will encourage government intervention to ensure that all company action is legal and fair. Regulators will also observe company mergers and acquisitions, to ensure that monopolistic companies are not likely to occur. If monopolies already exist within an industry, regulators will focus on barriers for new companies looking to enter a market and assess whether or not new entry points are necessary.
Even though these many metrics and terms allow us to understand the dynamics and market health of a particular industry, we cannot use them to directly compare two different companies in two unique markets. In order to compare market concentration between industries, we need to analyze how specific factors that change one market operate compared to a market without that particular factor. It takes a thorough understanding of both markets to directly compare them. Even if this is true, companies known as market whales are universally dominant across markets, industries, and sectors.
Market whales are a term that identifies individuals and firms that possess very high financial resources and control very large market share. Market whales will usually take the form of investment firms, hedge funds, and mutual funds. For further context, hedge funds are partnerships of investors that make high-risk investments in hopes of high returns, while mutual funds focus on more reliable investments such as securities and government bonds. Because of their enormous – whale like – dominance, market whales are able to control and influence individual markets with ease. One of the most prevalent market whales today is BlackRock. With trillions of dollars in assets, they have established themselves as the largest asset management firm, even having significant global impact. Some other market whales that dominate several financial markets include Vanguard, which manages many leading index funds and ETFs, State Street Global Advisors, which manages the S&P 500 ETF, and Fidelity. They each have extensive influence on the market through their holdings, and power to mold investment trends and market behavior.
But a question may arise, how exactly is a market whale different from a monopoly? Well, we can start by examining business models. Market whales tend to develop their wealth and control through capitalizing on strong investments, rather than solving a problem through a good or service. In the same sense monopolies control single industries, market whales dominate multiple sectors. Simply put, market whales are focused on developing their investments and assets rather than providing and developing an industry-specific good or service.
But with so much control over many markets and possession of high holdings, how can market whales influence factors outside of financial markets? As market whales transact high amounts of assets, they can significantly influence stock prices and company valuations. At an extremely large scale, these transactions can even influence GDP calculations. Market whales can also funnel their investments towards specific industries, which can lead to either economic growth or decline and a shift in employment levels. They can also force companies into making very specific financial decisions as a result of a large shareholder selling or buying more of their stock. Although they can prove to be very influential in metrics such as GDP, and single company financial decisions, market whales are one of many varying factors that contribute to economic health as a whole.