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What Is Herfindahl-Hirschman Index (HHI)?

The Herfindahl-Hirschman Index (HHI) is a common measure of market concentration that is used to determine market competitiveness, especially in the context of mergers and acquisitions. Within the broader field of market structure analysis, the HHI provides a quick and quantitative indicator of how concentrated a market is. A higher HHI value generally indicates a less competitive market and a higher degree of market power held by a few firms. This index is a crucial tool for regulatory bodies like the U.S. Department of Justice (DOJ) and the Federal Trade Commission (FTC) when evaluating the potential antitrust implications of proposed corporate consolidations.

History and Origin

The Herfindahl-Hirschman Index's roots trace back to the mid-20th century. It is named after Orris C. Herfindahl, an American economist who proposed a similar measure in his 1950 doctoral dissertation, and Albert O. Hirschman, who published a related index in 1945. The HHI gained prominence in antitrust enforcement in the United States, becoming a key quantitative tool for assessing the competitive landscape of industries.

The U.S. Department of Justice (DOJ) and the Federal Trade Commission (FTC) officially adopted the HHI in their 1982 Merger Guidelines, a significant step that formalized its role in U.S. antitrust law. These guidelines, and subsequent revisions, outline the specific thresholds at which the agencies consider a market to be concentrated and when a merger might raise competitive concerns. For example, the 1992 Horizontal Merger Guidelines detailed how the HHI would be used to classify markets and assess the impact of mergers.¹⁰ The framework continues to evolve, with the 2023 Merger Guidelines setting updated, often lower, thresholds for presuming a merger is unlawful based on HHI changes and resulting market concentration.⁸, ⁹

Key Takeaways

• The Herfindahl-Hirschman Index (HHI) measures market concentration and is used to assess competitiveness.
• It is calculated by squaring the market share of each firm in a market and summing the results.
• A higher HHI indicates greater market concentration and potentially less competition.
• The HHI is a primary tool for antitrust authorities in evaluating the impact of mergers.
• Thresholds set by regulatory bodies determine when a market is considered moderately or highly concentrated.

Formula and Calculation

The Herfindahl-Hirschman Index (HHI) is calculated by taking the market share of each firm in an industry, squaring each of those percentages, and then summing the resulting numbers.

The formula for the HHI is:

Where:

• ( s_i ) = the market share of firm i (expressed as a percentage, e.g., 20 for 20%)
• ( N ) = the total number of firms in the market

For example, if a market has three firms with market shares of 40%, 30%, and 30%, the HHI would be calculated as:
HHI = ( 40^2 + 30^2 + 30^2 ) = ( 1600 + 900 + 900 ) = 3400.

The HHI takes into account the relative size distribution of the firms in a market. It approaches zero when a market is occupied by a large number of firms of relatively equal size and reaches its maximum of 10,000 points (when expressed using percentages) when a market is controlled by a single firm, or a monopoly.⁷

Interpreting the Herfindahl-Hirschman Index

Interpreting the HHI involves understanding the ranges and thresholds used by antitrust regulators to classify market concentration. Generally, the scale runs from near zero (perfect competition with many small firms) to 10,000 (a pure monopoly).

The U.S. Department of Justice and the Federal Trade Commission typically use the following classifications for market concentration, based on the HHI⁶:

• Unconcentrated Markets: HHI below 1,000 (or 1,500 in previous guidelines).
• Moderately Concentrated Markets: HHI between 1,000 and 1,800.
• Highly Concentrated Markets: HHI above 1,800.

Furthermore, the agencies examine the change in the HHI (ΔHHI) caused by a merger. A merger that increases the HHI by more than 100 points in a highly concentrated market (HHI above 1,800) is generally presumed to raise competitive concerns and is likely to enhance market power or facilitate its exercise. ⁴, ⁵This framework helps regulators assess whether a proposed transaction could lead to reduced competition, potentially harming consumers through higher prices or reduced innovation.

Hypothetical Example

Consider a hypothetical market for specialized industrial components, currently served by four manufacturers: Alpha Corp, Beta Ltd, Gamma Inc, and Delta Manufacturing. Their current market shares are:

• Alpha Corp: 35%
• Beta Ltd: 30%
• Gamma Inc: 20%
• Delta Manufacturing: 15%

First, calculate the current HHI:
Current HHI = ( 35^{2 + 30}2 + 20^{2 + 15}2 )
Current HHI = ( 1225 + 900 + 400 + 225 ) = 2750

This market is highly concentrated, as its HHI of 2750 is above the 1800 threshold.

Now, imagine Alpha Corp proposes to acquire Delta Manufacturing. After the mergers and acquisitions, the new market shares would be:

• Alpha Corp (combined): ( 35% + 15% = 50% )
• Beta Ltd: 30%
• Gamma Inc: 20%

Calculate the new HHI:
New HHI = ( 50^2 + 30^2 + 20^2 )
New HHI = ( 2500 + 900 + 400 ) = 3800

The change in HHI (ΔHHI) resulting from this merger would be:
ΔHHI = New HHI - Current HHI = ( 3800 - 2750 ) = 1050

Since the post-merger HHI is 3800 (highly concentrated) and the ΔHHI is 1050 (well over 100), this proposed merger would likely face significant scrutiny from antitrust authorities, as it substantially increases economic concentration in an already concentrated market.

Practical Applications

The Herfindahl-Hirschman Index (HHI) finds its most prominent practical application in antitrust analysis and merger review. Government agencies like the U.S. Department of Justice (DOJ) and the Federal Trade Commission (FTC) use the HHI as a screening tool to identify proposed mergers and acquisitions that might significantly lessen competition in a relevant market.

Beyond merger review, the HHI is also used in:

• Industry Analysis: Economists and analysts use the HHI to gauge the competitive intensity of various industries. A persistently high HHI in an industry might signal the presence of an oligopoly or other non-competitive market structures.
• Academic Research: Researchers use the HHI to study the effects of market concentration on factors such as innovation, pricing strategies, and industry performance.
• Policy Making: The HHI informs discussions about deregulation or interventions aimed at fostering competition in specific sectors where economic concentration is deemed too high.
• Business Strategy: Companies can use HHI analysis to understand their position within a market and anticipate potential regulatory hurdles for future growth strategies. For instance, the 2023 Merger Guidelines from the DOJ and FTC highlight an increased scrutiny of proposed transactions, particularly those that result in an HHI above 1,800 and an increase of more than 100 points, or where the combined firm has more than a 30% market share. Thi², ³s signals a more aggressive enforcement stance, making HHI analysis critical for businesses considering strategic moves.

Limitations and Criticisms

While a widely used and valuable tool, the Herfindahl-Hirschman Index (HHI) has several limitations and has faced criticisms:

• Market Definition Challenges: The accuracy of the HHI heavily relies on the correct definition of the relevant market. Defining a market too broadly or too narrowly can significantly skew the HHI calculation. For example, if "soft drinks" is the market, a merger between two cola companies might seem less impactful than if the market is defined as "cola beverages." This issue often leads to extensive debates during antitrust reviews.
• Ignores Potential Competition: The HHI only considers existing firms and their current market share. It does not account for potential new entrants, the threat of substitutes, or dynamic market shifts that could increase competition in the future, even in a highly concentrated market.
• Does Not Capture Strategic Behavior: The HHI is a static measure and does not fully capture complex strategic interactions between firms, such as the potential for collusion or price fixing, nor does it account for buyer power or efficiencies like economies of scale that a merger might create.
• Thresholds Are Arbitrary: While the thresholds used by antitrust agencies provide clear guidance, they are ultimately administrative constructs. A market with an HHI of 1790 might be considered moderately concentrated, while 1810 is highly concentrated, even if the real-world competitive dynamics are very similar. The setting of these thresholds can be subject to policy changes, as seen with the revised 2023 Merger Guidelines, which lowered the thresholds compared to previous versions.

De¹spite these limitations, the HHI remains a cornerstone of antitrust analysis due to its quantitative simplicity and broad acceptance as an initial indicator of market concentration.

Herfindahl-Hirschman Index vs. Concentration Ratio

The Herfindahl-Hirschman Index (HHI) and the Concentration Ratio are both measures of market concentration, but they differ in their sensitivity to the distribution of market share among firms.

The primary difference lies in how each index weights firms. By squaring each firm's market share, the HHI gives proportionally more weight to larger firms. This means that a merger between two large firms will result in a much larger increase in the HHI than a merger between two smaller firms, even if the absolute change in combined market share is the same. The Concentration Ratio, conversely, simply sums the market shares of the top N firms, making it less sensitive to changes in the largest firms' sizes or the distribution of shares among those firms. For instance, a four-firm concentration ratio (CR4) would only consider the market shares of the four largest firms, ignoring the influence of other players in the market.

FAQs

What does a high HHI mean?

A high Herfindahl-Hirschman Index (HHI) indicates that a market is highly concentrated, meaning a small number of firms account for a large proportion of the total sales or output. This generally suggests less competition and potentially a greater risk of reduced consumer choice, higher prices, or less innovation. Antitrust authorities typically view markets with an HHI above 1,800 as highly concentrated.

Is an HHI of 10,000 possible?

Yes, an HHI of 10,000 is theoretically possible. It would occur in a market where there is only one firm, holding 100% of the market share. This scenario represents a pure monopoly.

How is the HHI used by regulators?

Regulatory bodies, such as the U.S. Department of Justice (DOJ) and the Federal Trade Commission (FTC), use the HHI as a key metric to assess the potential impact of proposed mergers and acquisitions on market competition. They calculate the HHI both before and after a merger. If the post-merger HHI exceeds certain thresholds (e.g., 1,800) and the change in HHI is significant (e.g., over 100 points), the merger may be presumed to lessen competition substantially, triggering further investigation or potential challenge under antitrust law.