Herfindahl-Hirschman Index (HHI)

Definition

The Herfindahl-Hirschman Index (HHI) measures market concentration by quantifying the relative size of firms within an industry. It is commonly used by regulators and economists to assess competitiveness and to evaluate potential antitrust issues in mergers and acquisitions.

Formula and calculation

HHI is calculated by squaring the market share of each firm (expressed as a whole-number percentage) and summing the results:

HHI = s1^2 + s2^2 + … + sn^2

where sn is the market share percentage of firm n (e.g., use 25 for 25%, not 0.25).
The HHI ranges from near 0 (many small firms, near-perfect competition) to 10,000 (100^2, a single-firm monopoly).

Interpreting HHI

Common benchmarks used in merger review:
– HHI < 1,500: competitive marketplace
– 1,500 ≤ HHI < 2,500: moderately concentrated
– HHI ≥ 2,500: highly concentrated

Regulators (e.g., U.S. Department of Justice and FTC) consider mergers that raise the HHI substantially — typically by more than 200 points in already highly concentrated markets — as likely to raise antitrust concerns.

Example

Industry with four firms:
– Firm A: 40% → 40^2 = 1,600
– Firm B: 30% → 30^2 = 900
– Firm C: 15% → 15^2 = 225
– Firm D: 15% → 15^2 = 225

HHI = 1,600 + 900 + 225 + 225 = 2,950 → highly concentrated.

Other illustrative cases:
– One firm 48.59% and 19 firms at 2.71% each → HHI = 2,500.
– One firm 35.82% and 19 firms at 3.38% each → HHI = 1,500.

What HHI reveals

• Higher HHI indicates greater market concentration and less competition.
• Lower HHI indicates a more competitive market with many small players.
• HHI weights large firms more heavily, so it reflects the influence of dominant firms better than simple concentration ratios.

Limitations

• Sensitive to how the market is defined (product scope, geographic boundaries). Poor market delineation can produce misleading HHI values.
• Masks within-market segmentation: a firm may dominate a particular product or region even if overall HHI appears low.
• Simplifies competitive dynamics; it does not account for potential competition, barriers to entry, or other market frictions.

History

The concept originated with Albert O. Hirschman (1945), who emphasized weighting larger shares more heavily. Orris C. Herfindahl later applied and popularized the measure in his 1950 dissertation analyzing industry concentration; the combined name reflects both contributions.

Key takeaways

• HHI = sum of squared market-share percentages; range 0–10,000.
• Used by regulators to assess market concentration and merger effects.
• Benchmarks: <1,500 (competitive), 1,500–2,500 (moderately concentrated), ≥2,500 (highly concentrated).
• Advantage: simple to compute and sensitive to firm size.
• Limitation: requires careful market definition and does not capture all competitive factors.