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What Is HHI?

The Herfindahl-Hirschman Index (HHI) is a widely used measure of market concentration, employed by economists and regulatory bodies within the field of market analysis and antitrust economics. It quantifies the size of firms in relation to the industry and indicates the degree of competition among them. A higher HHI value signifies a more concentrated market, potentially suggesting less competition and a higher likelihood of market power.

The HHI takes into account the respective market share of all firms within a given industry, offering a more comprehensive view of the competitive landscape compared to simpler measures that might only look at the largest few firms. This index is crucial for understanding how market structures might impact consumer welfare, innovation, and economic efficiency.

History and Origin

The Herfindahl-Hirschman Index emerged from the work of two economists: Orris C. Herfindahl, who discussed it in his 1950 dissertation, and Albert O. Hirschman, who independently developed a similar concentration measure in 1945. While both contributed to its theoretical foundation, it was in the latter half of the 20th century that the HHI gained prominence as a practical tool for antitrust enforcement. The U.S. Department of Justice (DOJ) and the Federal Trade Commission (FTC) formally adopted the HHI in their 1982 Horizontal Merger Guidelines, solidifying its role in evaluating proposed merger and acquisition activities. Since then, the HHI has remained a cornerstone of antitrust analysis, with its thresholds periodically reviewed and updated to reflect economic understanding and enforcement priorities. For instance, the DOJ provides detailed explanations of how the HHI is calculated and its significance in assessing market concentration.¹⁰

Key Takeaways

• The HHI measures market concentration by summing the squares of individual market share percentages of all firms in an industry.
• It is a key tool used by regulatory bodies, such as the U.S. Department of Justice and the Federal Trade Commission, to assess the potential competitive impact of mergers.
• Higher HHI values indicate greater market concentration and potentially less competition.
• The HHI helps identify markets that might be approaching a monopoly or oligopoly structure.
• Thresholds for interpreting HHI values are regularly updated by antitrust authorities to guide enforcement actions.

Formula and Calculation

The Herfindahl-Hirschman Index is calculated by summing the squares of the individual market shares of all firms in a specific market. Each firm's market share is expressed as a whole number percentage (e.g., 30 for 30%).

The formula for the HHI is:

Where:

• ( N ) = the total number of firms in the market
• ( S_i ) = the market share of firm ( i ), expressed as a whole number percentage.

For example, if a market has four firms with market shares of 30%, 30%, 20%, and 20%, the HHI would be calculated as: ( 30^{2 + 30}2 + 20^{2 + 20}2 = 900 + 900 + 400 + 400 = 2600 ). The calculation directly reflects the impact of firm size distribution, giving more weight to larger firms.

Interpreting the HHI

Interpreting the HHI involves evaluating the resulting numerical value to understand the level of market concentration. Generally, the index ranges from near zero (for a market with a very large number of extremely small firms) to 10,000 (for a pure monopoly where one firm has 100% market share).

Antitrust authorities, such as the U.S. Department of Justice and the Federal Trade Commission, use specific HHI thresholds to classify market concentration and guide their review of proposed mergers. According to the 2023 Horizontal Merger Guidelines, markets are categorized as follows:

• Unconcentrated: Post-merger HHI below 1,000. Mergers in these markets are generally unlikely to raise significant competitive concerns.⁹
• Moderately Concentrated: Post-merger HHI between 1,000 and 1,800. Mergers in these markets might raise competitive concerns if the HHI increases by more than 100 points.⁸
• Highly Concentrated: Post-merger HHI above 1,800. Mergers that result in an HHI above 1,800 and increase the HHI by more than 100 points are generally presumed to enhance market power or facilitate its exercise, potentially raising significant competitive concerns.⁷,⁶

These thresholds help regulatory bodies determine when further scrutiny of a proposed merger is warranted, focusing on its potential impact on competition and consumers.

Hypothetical Example

Consider a hypothetical market for specialized industrial components, which currently has five active firms.

• Firm A: 35% market share
• Firm B: 25% market share
• Firm C: 20% market share
• Firm D: 10% market share
• Firm E: 10% market share

Step 1: Calculate the pre-merger HHI.

Now, suppose Firm D decides to acquire Firm E. After the merger and acquisition, the new market shares would be:

• Firm A: 35%
• Firm B: 25%
• Firm C: 20%
• Merged Firm (D+E): 10% + 10% = 20%

Step 2: Calculate the post-merger HHI.

Step 3: Calculate the change in HHI ((\Delta HHI)).

In this example, the pre-merger HHI of 2450 indicates a highly concentrated market. The merger results in a post-merger HHI of 2650 and an increase of 200 points. Based on U.S. antitrust guidelines, a post-merger HHI above 1,800 and an increase of more than 100 points would raise significant competitive concerns, likely prompting a thorough review by antitrust authorities due to the potential for reduced competition and negative impacts on supply and demand dynamics.

Practical Applications

The HHI is predominantly used in antitrust laws and competition policy. Government agencies, such as the U.S. Department of Justice (DOJ) and the Federal Trade Commission (FTC), rely on the HHI to assess the potential impact of proposed mergers and acquisitions on market competition. If a merger significantly increases the HHI in an already concentrated market, it may be challenged to prevent the creation or enhancement of market power that could harm consumers through higher prices, reduced output, or less innovation.

Beyond merger review, the HHI can also be applied in other areas of financial and economic analysis. It can serve as a metric in academic research to study industrial organization, evaluate industry trends, or understand the relationship between market structure and firm performance. Analysts might use it to gauge the competitiveness of an industry when conducting business valuation or developing an investment strategy. The FTC and DOJ's issuance of new merger guidelines in December 2023 underscores the ongoing importance of the HHI in regulatory oversight of markets.⁵

Limitations and Criticisms

While a widely used measure, the HHI has certain limitations and criticisms. One primary challenge lies in accurately defining the "relevant market," which can be subjective and significantly influence the HHI calculation. A narrowly defined market might make an industry appear more concentrated than it is, while a broadly defined one could obscure significant concentration within a specific product niche. The "hypothetical monopolist" test is often used to define relevant markets, but its application can be complex.⁴

Another critique is that the HHI is a static measure and does not fully capture the dynamic nature of markets, including potential entry by new firms or rapid technological innovation that could quickly alter market shares. It also doesn't account for factors like product differentiation, the strength of competition from substitute products, or the bargaining power of buyers and suppliers. For instance, a market with a high HHI might still be highly competitive if there are low barriers to entry or if existing firms are constantly innovating. The Federal Reserve Board provides a primer on market power and antitrust review, highlighting various complexities beyond simple concentration measures.³

Furthermore, relying solely on HHI thresholds can sometimes lead to an overly simplistic view, potentially flagging mergers that are actually pro-competitive due to efficiencies or benefits to consumers. Conversely, some anti-competitive mergers might slip through if the HHI change is below the threshold but other factors suggest harm to competition. Analysts engaged in risk management must consider these nuances when using the HHI.

HHI vs. Concentration Ratio

The HHI and the concentration ratio are both tools used to measure market concentration, but they differ in their methodology and the insights they provide.

The Concentration Ratio typically measures the combined market share of the largest 'N' firms in an industry (e.g., CR4 for the top four firms, CR8 for the top eight). It is a simple sum of percentages. For example, a CR4 of 60% means the four largest firms collectively control 60% of the market. This measure is straightforward but offers limited insight into the distribution of market shares among those top firms or the structure of the rest of the market. Two industries could have the same CR4, but one might have a dominant leader while the other has four equally sized large firms.

The Herfindahl-Hirschman Index (HHI), as discussed, sums the squares of the market shares of all firms in the market. By squaring the market shares, the HHI gives proportionally greater weight to larger firms. This means it is more sensitive to the presence of large firms and changes in their market shares. For instance, a merger between two small firms would have a much smaller impact on the HHI than a merger between two large firms, even if the absolute change in combined market share is the same. This sensitivity makes the HHI a more refined measure for assessing the potential for market power and is why antitrust authorities favor it over simpler concentration ratios.

While the concentration ratio provides a quick snapshot of the market share held by leading firms, the HHI offers a more nuanced understanding of the overall market structure and the relative competitive influence of individual firms.

FAQs

What does a low HHI indicate?

A low HHI indicates a highly competitive and fragmented market, where many firms have relatively small and equal market share. This suggests a healthy competitive landscape and lower risk of any single firm exerting undue market power.

Why does the HHI square market shares?

Squaring the market shares in the HHI calculation gives greater weight to larger firms. This means that a market with a few large firms will have a significantly higher HHI than a market with many small firms, even if the number of firms is the same. This feature makes the HHI particularly sensitive to shifts in the dominance of major players, which is critical for antitrust laws analysis.

Is the HHI used outside of antitrust?

While its primary application is in antitrust and competition policy, the HHI can be used by economists and financial analysts in other contexts. For instance, it might be used to assess the concentration of an industry when considering portfolio diversification strategies or to understand the competitive dynamics within sectors as part of broader economic research.

What are the "new" HHI merger guidelines?

The U.S. Department of Justice (DOJ) and the Federal Trade Commission (FTC) periodically update their Horizontal Merger Guidelines. The most recent significant revisions were issued in December 2023. These updated guidelines lowered the HHI thresholds for what constitutes a "highly concentrated" market (from 2,500 to 1,800) and for the increase in HHI that triggers presumptive illegality (from 200 to 100 points). These changes reflect a more aggressive stance by the regulatory bodies in scrutinizing mergers to prevent anticompetitive outcomes.²,¹