Concentration Ratio for a Merger

5/27/20

In this article I show some math proof for the phrase "whole is greater than the sum of its parts". Consider a company's market share and its concentration ratio.

Say companies a, b, and c are all that exist in an industry. They have sales of a, b, and c dollars. The sum of their sales is s = a + b + c.

Their market share is defined as a/s, b/s, and c/s, respectively. Their concentration ratios are (a/s)2, (b/s)2, and (c/s)2, or a2/s2, b2/s2, and c2/s2.

Now, consider that companies a and b merge, so the merged company has sales a+b. What can we say about the market share and concentration ratios now?

The sum s is unchanged. The market shares however become (a+b)/s and c/s, and the concentration ratios become [(a+b)/s]2 and (c/s)2. Expanding the first concentration ratio, we get [(a+b)/s]2 = (a2+b2+2ab) / s2.

Note that the numerator of the concentration ratio for the merged/combined company has an extra 2ab term, whereas the sum of the concentration ratios for the companies before the merge would only have a numerator of a2+b2.

What other things do we gain (or lose for that matter) when things merge?

Thanks for reading.


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