The principle of market fragmentation – that markets when they grow separate into sub-markers (or segments) that are diverse and vary in customer preferences, regulations, standards – is used to explain smaller (thin and insular) markets having less competition, higher prices, and keeping too many firms in business that would otherwise close.

For example, markets for cars have fragmented into sub-markets for: luxury cars, sports cars, family cars, etc.

Market fragmentation (a market that has grown and split into diverse sub-markets) initially leads to less competition in each sub-market (because the newly defined market smaller and therefore there are less competitors).

In smaller markets, firms have less competitors, and may lack an “up or out” dynamic where competitive pressures force them to: (a) merge with others, (b) improve their productivity (output per unit of input) and outcompete others, or (c) close down.