Hhi

What Is HHI?

The Herfindahl-Hirschman Index (HHI) is a widely recognized measure of market concentration used to assess the competitiveness of an industry. It quantifies the size of firms in relation to the overall industry and is a key indicator of the level of competition among them. A higher HHI value indicates greater market concentration and less competition, potentially pointing towards a market resembling an oligopoly or even a monopoly. This index is especially useful in market analysis and for evaluating the potential impact of mergers and acquisitions (M&A) on market dynamics.

History and Origin

The concept behind what is now known as the Herfindahl-Hirschman Index emerged independently from two economists in the mid-20th century. Albert O. Hirschman, a German economist, first introduced a similar measure in his 1945 book, "National Power and the Structure of Foreign Trade."²⁹, ³⁰ Hirschman's method aimed to quantify the concentration of international trade²⁸. A few years later, in 1950, American economist Orris C. Herfindahl independently developed a similar index in his doctoral dissertation, "Concentration in the U.S. Steel Industry," applying it to analyze the competitiveness within the steel industry²⁷. Herfindahl's dissertation, published on Archive.org, acknowledged Hirschman's earlier work. Due to their independent contributions, the index is named after both economists. Its adoption by antitrust authorities, particularly in the United States, cemented its importance as a standard tool for assessing market power and potential anti-competitive behavior²⁶.

Key Takeaways

• The HHI is a crucial measure of market concentration, calculated by summing the squares of the market share of all firms in a given market.
• It provides a more comprehensive view of concentration compared to simpler measures like concentration ratios, as it gives greater weight to larger firms.
• Regulators, such as the U.S. Department of Justice (DOJ) and Federal Trade Commission (FTC), widely use the HHI to evaluate the competitive effects of proposed mergers and acquisitions²⁴, ²⁵.
• Higher HHI values indicate greater market concentration and potentially less competition, while lower values suggest a more competitive market²³.
• Despite its widespread use, the HHI has limitations, including its sensitivity to market definition and its static nature²¹, ²².

Formula and Calculation

The HHI is calculated by taking the market share percentage of each firm in a specific market, squaring each of these percentages, and then summing the results. The result is typically expressed as a whole number ranging from near zero (for markets with many very small firms, indicating close to perfect competition) to 10,000 (for a pure monopoly with a single firm holding 100% market share).

The formula for the HHI is:

Where:

• (HHI) = Herfindahl-Hirschman Index
• (s_n) = the market share percentage of firm (n) (e.g., if a firm has 30% market share, use 30, not 0.30 in the calculation)²⁰.

Interpreting the HHI

The interpretation of the HHI is standardized by regulatory bodies, particularly in the context of antitrust reviews. The U.S. Department of Justice (DOJ) and the Federal Trade Commission (FTC) provide guidelines for interpreting HHI values:

• HHI below 1,500: Indicates an unconcentrated, competitive market.
• HHI between 1,500 and 2,500: Indicates a moderately concentrated market.
• HHI above 2,500: Indicates a highly concentrated market.

When evaluating mergers and acquisitions, regulators also consider the change in HHI (ΔHHI) caused by the proposed transaction. An increase of more than 100 points in a highly concentrated market (post-merger HHI above 1,800 or 2,500 depending on the specific guideline interpretation) typically raises antitrust concerns and triggers further scrutiny, as it suggests a significant increase in market power.¹⁷, ¹⁸, ¹⁹

Hypothetical Example

Consider a hypothetical market for widgets with four main companies. Their current market shares are:

• Company A: 40%
• Company B: 30%
• Company C: 20%
• Company D: 10%

To calculate the HHI for this market:

1. Square each company's market share:
   • Company A: (40^2 = 1,600)
   • Company B: (30^2 = 900)
   • Company C: (20^2 = 400)
   • Company D: (10^2 = 100)
2. Sum the squared values:
   • HHI = (1,600 + 900 + 400 + 100 = 3,000)

In this example, the market's HHI is 3,000. Based on the common interpretation, this indicates a highly concentrated market structure. If Company C were to acquire Company D, their combined share would be 30% (20% + 10%). The new market shares would be: Company A (40%), Company B (30%), and New Company C+D (30%). The post-merger HHI would be (40^2 + 30^2 + 30^2 = 1,600 + 900 + 900 = 3,400). The change in HHI (ΔHHI) would be (3,400 - 3,000 = 400). This significant increase in a highly concentrated market would likely raise substantial antitrust laws concerns.

Practical Applications

The HHI is a foundational tool in economic regulation and competitive analysis. Its primary practical applications include:

• Antitrust Enforcement: The U.S. Department of Justice (DOJ) and the Federal Trade Commission (FTC) use the HHI to assess the potential impact of proposed mergers and acquisitions on market competition. ¹⁶The 2023 Merger Guidelines issued by the FTC and DOJ specify HHI thresholds that trigger presumptions of illegality for certain mergers, aiming to address excessive market consolidation. ¹⁴, ¹⁵For instance, a horizontal merger resulting in a post-merger HHI above 1,800 with an increase of more than 100 points may be presumed unlawful.
  ¹³* Market Monitoring: Economists and policymakers utilize the HHI to monitor changes in market structure over time, identifying trends towards increased or decreased concentration within various industries, such as telecommunications or banking.
  ¹²* Investment Analysis: While not a direct investment metric, understanding the HHI of an industry can provide insights into its competitive landscape. Highly concentrated industries may indicate strong barriers to entry, potential for higher profit margins for dominant firms, but also increased regulatory scrutiny.
• Academic Research: The HHI is frequently used in academic studies to analyze the relationship between market concentration and various economic efficiency outcomes, including pricing behavior and innovation.
  ¹¹

Limitations and Criticisms

Despite its widespread use, the HHI has several limitations and has faced criticisms:

• Market Definition Challenges: The accuracy of the HHI heavily relies on how precisely the relevant market is defined. ¹⁰Defining a market too broadly or too narrowly can significantly skew the HHI calculation, potentially misrepresenting the actual level of competition. For example, defining the market as "beverages" instead of "soft drinks" would yield a very different concentration level.
• Static Measure: The HHI provides a snapshot of market concentration at a specific point in time and does not inherently account for dynamic competitive factors, such as potential new entrants, technological innovation, or evolving consumer preferences. ⁸, ⁹A market with a high HHI today might become less concentrated quickly due to disruptive innovation.
• Ignores Non-Price Competition: The index primarily focuses on market share and does not fully capture other forms of competition, such as product differentiation, quality improvements, or customer service.
  ⁷* Does Not Account for Entry Barriers: The HHI does not inherently consider barriers to entry that might prevent new firms from entering a concentrated market, which could maintain high levels of market power even if the HHI appears moderate.
  ⁶* Network Effects: In industries with strong network effects (where the value of a product or service increases with the number of users), a higher HHI might sometimes reflect positive externalities for consumers rather than purely anti-competitive concerns. Critics argue that the HHI's traditional application may not fully account for these benefits in network industries.
  ⁵

HHI vs. Concentration Ratio

Both the HHI and Concentration Ratio are measures of market concentration, but they differ in their calculation and the insights they provide.

The Concentration Ratio (CR) typically sums the market share of the largest 'n' firms in an industry (e.g., CR4 for the top four firms, CR8 for the top eight). For instance, a CR4 of 60% means the top four firms control 60% of the market. Its simplicity makes it easy to understand, but it provides limited detail about the distribution of market shares among the largest firms, or the competitive landscape outside of the top 'n' firms.

In contrast, the HHI considers the market share of all firms in the market, by squaring each firm's share and summing them. This squaring process gives disproportionately more weight to larger firms, making the HHI more sensitive to changes in the market share of bigger companies. This sensitivity is particularly useful in detecting potential increases in market power resulting from mergers and acquisitions, as even a merger between two relatively smaller firms might noticeably impact the HHI if they collectively gain significant ground. While the Concentration Ratio might show a similar number for two markets, the HHI can reveal whether one market has a few dominant players and many small ones, or many medium-sized players, offering a more nuanced view of the competitive structure.

FAQs

What does a high HHI mean?

A high HHI (typically above 2,500 points) indicates that a market is highly concentrated, meaning a small number of firms control a large proportion of the market share. This can suggest reduced competition and a higher potential for firms to exert market power.

How is the HHI used in antitrust cases?

Regulatory bodies like the Department of Justice (DOJ) and the Federal Trade Commission (FTC) use the HHI as a primary tool to evaluate proposed mergers and acquisitions. If a merger significantly increases the HHI in an already concentrated market, it may raise concerns about reduced competition and potentially violate antitrust laws, leading to further investigation or even legal challenge.
³, ⁴

Can a market with many firms still have a high HHI?

Yes. While a market with fewer firms generally has a higher HHI, it is possible for a market with many firms to still have a relatively high HHI if a few of those firms possess very large market shares. Because the HHI squares market shares, even one or two dominant firms can significantly inflate the index, reflecting their substantial influence on the market structure.

Is the HHI perfect for measuring market concentration?

No. While valuable, the HHI has limitations. It is a static measure that doesn't fully account for dynamic market changes, potential new entries, or non-price competition. ¹, ²Its accuracy is also highly dependent on the precise definition of the relevant market, which can be challenging in complex industries.