Hhi index

The Herfindahl-Hirschman Index (HHI) is a measure of market concentration used to gauge the competitiveness of an industry within the field of Antitrust Economics. The HHI considers the size of companies relative to the industry in which they operate, calculating competitiveness by summing the squares of the market share of each firm. A higher HHI indicates increased economic concentration and reduced competition, while a lower HHI suggests a more fragmented and competitive market. It is widely used by regulators to assess the potential impact of events like merger and acquisition transactions on market structure.

History and Origin

The conceptual foundation of what is now known as the Herfindahl-Hirschman Index emerged independently from the work of two economists in the mid-20th century. Albert O. Hirschman developed the concept in 1945 as part of his doctoral research, using a variant of the index to analyze trade patterns²⁹, ³⁰. Five years later, in 1950, Orris C. Herfindahl independently created an identical index for his doctoral dissertation on the steel industry, proposing its use for regulatory purposes²⁸.

The HHI gained widespread recognition in antitrust laws during the 1960s, with Hirschman playing a role in popularizing its use in industrial organization economics²⁷. Although early U.S. Department of Justice (DOJ) and Federal Trade Commission (FTC) merger guidelines initially used concentration ratios, subsequent guidelines adopted the HHI as a primary screening tool for potential antitrust concerns arising from mergers due to its more comprehensive approach to measuring market structure²⁶. The U.S. Department of Justice's Antitrust Division now provides a handbook detailing its use of the HHI.²⁵

Key Takeaways

• The Herfindahl-Hirschman Index (HHI) measures market concentration by summing the squares of individual firm market shares.
• It is a key tool in antitrust enforcement, particularly for evaluating the competitive impact of mergers and acquisitions.²⁴
• The HHI ranges from a value close to zero (indicating many small firms and high competition) to 10,000 (representing a pure monopoly).
• Higher HHI values signal greater market concentration and potential for reduced competition or increased market power.²³
• While simple to calculate, the HHI has limitations, especially in defining the relevant market and capturing its complexities.

Formula and Calculation

The Herfindahl-Hirschman Index is calculated by summing the squares of the market shares of all firms within a specific market. When market shares are expressed as whole numbers (e.g., 25 for 25%), the HHI can range from nearly 0 to 10,000.²²

The formula is expressed as:

Where:

• ( HHI ) = Herfindahl-Hirschman Index
• ( s_i ) = the market share of firm ( i ) (expressed as a percentage, e.g., 30 for 30%)
• ( N ) = the total number of firms in the market

This approach gives greater weight to firms with larger market shares due to the squaring of each share, making the HHI a more sensitive measure of concentration than simple sum-based ratios.²¹

Interpreting the HHI

The interpretation of the Herfindahl-Hirschman Index provides insights into the level of competition and potential for market power within an industry. The U.S. Department of Justice and the Federal Trade Commission use specific thresholds to classify market concentration:

• HHI below 1,500: Considered an unconcentrated or competitive market.²⁰
• HHI between 1,500 and 2,500: Indicates a moderately concentrated market.¹⁹
• HHI above 2,500: Signifies a highly concentrated market.¹⁸

In contexts of proposed mergers or acquisitions, a significant increase in the HHI—typically more than 200 points in highly concentrated markets—can raise antitrust concerns and trigger further scrutiny by regulators. A m¹⁶, ¹⁷arket with a single firm holding 100% market share would result in an HHI of 10,000, representing a pure monopoly. Conversely, a market with numerous tiny firms, each with a negligible market share, would have an HHI approaching zero, indicative of perfect competition.

Hypothetical Example

Consider an industry with five companies (Firm A, B, C, D, and E) that hold the following market shares:

• Firm A: 40%
• Firm B: 25%
• Firm C: 20%
• Firm D: 10%
• Firm E: 5%

To calculate the HHI for this market:

1. Square each firm's market share:
   • Firm A: (40^2 = 1600)
   • Firm B: (25^2 = 625)
   • Firm C: (20^2 = 400)
   • Firm D: (10^2 = 100)
   • Firm E: (5^2 = 25)
2. Sum the squared market shares:
   • (HHI = 1600 + 625 + 400 + 100 + 25 = 2750)

In this hypothetical scenario, the HHI of 2750 indicates a highly concentrated market, surpassing the 2,500 threshold used by U.S. antitrust authorities. This level of economic concentration suggests that the industry might be prone to reduced competition or the exercise of market power.

Practical Applications

The Herfindahl-Hirschman Index is a foundational metric with significant applications across economics and regulation. Its primary use is in antitrust enforcement to assess market concentration, particularly during the review of proposed mergers and acquisitions. Re¹⁵gulatory bodies, such as the U.S. Department of Justice (DOJ) and the Federal Trade Commission (FTC), routinely use the HHI to evaluate whether a proposed combination could substantially lessen competition or tend to create a monopoly. If¹⁴ a merger significantly increases the HHI in an already concentrated market, it can trigger closer scrutiny and potentially be challenged.

Be¹³yond merger review, the HHI is also applied in general industry analysis to understand the prevailing market structure and identify sectors that may warrant further examination for anti-competitive practices. For instance, reports on market concentration often utilize the HHI to gauge the level of economic concentration across various industries. The Federal Trade Commission publishes primers on the HHI that detail its use in assessing market concentration and competition. [FTC HHI Primer]

Limitations and Criticisms

Despite its widespread adoption and simplicity, the Herfindahl-Hirschman Index has notable limitations. A primary criticism is its reliance on how the "relevant market" is defined. An overly broad or narrow definition of a market can significantly skew the HHI calculation, potentially leading to inaccurate assessments of competition. Fo¹²r example, a national HHI calculation might suggest high competition, but if distinct regional markets exist where individual firms hold dominant positions, the HHI could mask local monopoly conditions.

Another criticism points out that while the HHI indicates market concentration, it doesn't always fully capture the dynamic nature of market forces, such as the ease of entry for new firms or the potential for disruptive innovation. A ¹¹market with a high HHI might still be highly competitive if entry barriers are low. Some academic critiques highlight that the HHI, due to its simplicity, may not always provide a genuinely accurate assessment of complex competitive or monopolistic market conditions. For¹⁰ instance, the Federal Reserve Bank of San Francisco has published discussions on challenges in measuring market power, which implicitly touch upon the difficulties in relying solely on such indices. [FRBSF Economic Letter on Market Power] The Organisation for Economic Co-operation and Development (OECD) also explores various aspects of market concentration and competition, acknowledging the complexities beyond simple metrics. [OECD Market Concentration]

HHI Index vs. Concentration Ratio

The Herfindahl-Hirschman Index (HHI) and the Concentration Ratio are both measures of market concentration, but they differ in their scope and the weight they assign to firms.

The Concentration Ratio typically sums the market shares of a fixed number of the largest firms in an industry, such as the top four (CR4) or eight (CR8) firms. Th⁹is provides a quick snapshot of the dominance of the leading companies. For example, a CR4 of 60% means the four largest firms collectively control 60% of the market.

In contrast, the HHI takes into account the market shares of all firms in the industry by squaring each share and then summing them. Th⁸is mathematical operation gives disproportionately greater weight to larger firms. This distinction makes the HHI a more sensitive measure of market structure because it reflects not only the number of firms but also the disparity in their sizes. If⁶, ⁷ two industries have the same four-firm concentration ratio, the one with a more unequal distribution of market shares among those top firms (i.e., one firm is much larger than the others) will have a higher HHI. The⁵refore, the HHI is generally considered a more precise measure of economic concentration as it captures the full distribution of market shares.

##⁴ FAQs

What is a good HHI score?

There isn't a single "good" HHI score, as the interpretation depends on the industry and regulatory context. However, for U.S. antitrust purposes, an HHI below 1,500 typically indicates a competitive market, between 1,500 and 2,500 is moderately concentrated, and above 2,500 is highly concentrated. A l³ower HHI generally suggests greater competition and less potential for a single firm or small group of firms to exert undue market power.

What does an HHI of 10,000 mean?

An HHI of 10,000 signifies a pure monopoly, where one firm holds 100% of the market share. In such a scenario, the calculation would be (100^2 = 10,000). This indicates an absence of competition in that specific market.

Is a higher HHI better or worse?

From a consumer and competition policy perspective, a higher HHI is generally considered "worse" because it indicates greater market concentration and a potentially reduced level of competition. This can lead to increased prices, reduced innovation, and fewer choices for consumers. Regulators often scrutinize markets with high HHI values or proposed mergers that would significantly increase the HHI.

How is the HHI used by the government?

The U.S. Department of Justice (DOJ) and the Federal Trade Commission (FTC) primarily use the HHI as a screening tool to evaluate the competitive implications of proposed mergers and acquisitions. The²y calculate the HHI before and after a proposed transaction to determine if it would lead to an unacceptable increase in market concentration that could harm consumers by lessening competition. Mergers that result in a significant increase in HHI in already concentrated markets are more likely to be challenged under antitrust laws.

[F¹TC HHI Primer]: https://www.ftc.gov/system/files/documents/reports/herfindahl-hirschman-index-basic-primer/hhi_primer_report.pdf
[FRBSF Economic Letter on Market Power]: https://www.frbsf.org/economic-research/publications/economic-letter/2018/september/rising-market-power-a-problem-for-everyone/
[OECD Market Concentration]: https://www.oecd.org/daf/competition/concentration-economic-activity-industry-analysis.htm