• The Herfindahl–Hirschman Index (HHI) is a widely used single-number measure of market concentration.
– HHI = sum of the squared market-share percentages of all firms in the defined market; it ranges from close to 0 (many small firms) to 10,000 (single-firm monopoly).
– The U.S. antitrust agencies use HHI thresholds to screen mergers: 2,500 (highly concentrated). Mergers that raise HHI by >200 points in highly concentrated markets typically trigger close antitrust scrutiny.
– HHI is simple and effective for a first pass, but it must be paired with careful market definition and additional qualitative and quantitative analysis.
What is the HHI?
The Herfindahl–Hirschman Index (HHI) quantifies how market share is distributed among firms in a product/geographic market. It weights larger firms more heavily (because shares are squared), so industries dominated by a few large firms generate high HHIs while fragmented industries generate low HHIs. Regulators, economists, and corporate analysts commonly use HHI for competition assessment, particularly in merger reviews.
Formula and how to calculate it
Formula:
HHI = s1^2 + s2^2 + s3^2 + … + sn^2
where sn = market share of firm n expressed as a whole-number percentage (not decimal).
Step-by-step calculation (practical steps)
1. Define the market precisely:
• Specify the product market (what products/services are included).
• Specify the geographic market (local, regional, national, global).
• Consider potential substitutes and demand-side switching (SSNIP test can help).
2. Select the appropriate measure of “market” size:
• Use sales revenue, unit shipments, customer counts, or another consistent metric for the market and each firm.
• Use a defined time period (typically last 12 months).
3. Compute each firm’s market share (as a percentage):
• Market share = (firm’s sales in the market / total market sales) × 100.
4. Square each firm’s market share percentage.
5. Sum the squared shares to get the HHI.
6. Interpret the HHI using standard thresholds and context (see next section).
Quick examples
– Monopoly: one firm with 100% share → HHI = 100^2 = 10,000.
– Highly concentrated example (four firms): shares 40%, 30%, 15%, 15%:
HHI = 40^2 + 30^2 + 15^2 + 15^2 = 1,600 + 900 + 225 + 225 = 2,950 (highly concentrated).
– Many small firms: if thousands of firms each have near-zero share, HHI approaches 0 (highly competitive).
Interpreting HHI (standard benchmarks)
– HHI 2,500: highly concentrated.
For mergers, regulators typically:
– Flag transactions in unconcentrated markets that raise HHI by more than 100 points.
– Scrutinize transactions in moderately concentrated markets that raise HHI by more than 100–200 points.
– Are especially concerned if a merger in a highly concentrated market increases HHI by more than 200 points.
(These thresholds are those used as screening guidance by the U.S. Department of Justice and Federal Trade Commission in their Horizontal Merger Guidelines.)
Using HHI for merger analysis — practical steps
1. Calculate pre‑merger HHI using current market shares.
2. Calculate the merged firm’s new market share: combine the merging parties’ shares.
3. Recompute the HHI with the merged shares to get post‑merger HHI.
4. Compute the change: ΔHHI = post‑merger HHI − pre‑merger HHI.
5. Compare ΔHHI and post‑merger HHI to enforcement thresholds to determine whether the merger warrants further competitive analysis.
6. Supplement HHI screening with deeper analysis: diversion ratios, price effects, entry conditions, efficiencies claimed by merger parties, buyer power, and customer switching costs.
Worked merger example
Pre-merger market shares: A = 40%, B = 30%, C = 15%, D = 15% → HHI = 2,950 (highly concentrated).
If B (30%) and C (15%) merge, combined share = 45% → post-merger shares 40%, 45%, 15% → HHI = 1,600 + 2,025 + 225 = 3,850.
ΔHHI = 900 points — a very large increase that would raise strong antitrust concerns under standard screening guidance.
Advantages of the HHI
– Simple to compute and interpret.
– Gives greater weight to large firms (sensitivity to dominant-firm effects).
– Standardized thresholds are widely used by competition agencies, making it useful in compliance and M&A screening.
Limitations and cautions
– Market definition sensitivity: HHI is only as meaningful as the product and geographic market definitions used.
– Static snapshot: it does not capture dynamic factors such as entry, innovation, or rapid demand shifts.
– Ignores firm heterogeneity in important dimensions (e.g., product differentiation, buyer power, vertical relationships).
– Data quality: requires accurate sales/volume data; small errors can change interpretation near threshold levels.
– Localized concentration: even if national HHI is low, regional/local HHIs may be high (and vice versa).
– Fails to capture competitive interactions like cross-market competition, multi-product firms, or future competitive constraints.
When to go beyond HHI
– If a merger screens close to thresholds, perform detailed competitive effects analysis (diversion ratios, price-cost margins, customer-switching data).
– If product markets are differentiated (features, quality), use demand-side evidence and price/cross-elasticity analysis.
– If potential entry is likely and timely, incorporate entry modeling and scenario analysis.
History and origin
– The weighting concept originated with Albert O. Hirschman’s 1945 work on concentration in trade.
– Orris C. Herfindahl applied the squared-share measure to industrial concentration in his 1950 doctoral dissertation on the U.S. steel industry. The combined name (Herfindahl–Hirschman Index) recognizes both contributors.
Practical checklist for analysts (one-page action list)
1. Define market (product + geography) and justify definition.
2. Choose metric (revenues, volumes) and time window.
3. Collect firm-level data; verify large players and cross-check sources.
4. Calculate market shares and compute HHI.
5. For M&A: compute pre- and post-merger HHI and ΔHHI.
6. Compare to regulatory thresholds.
7. Run sensitivity analyses (e.g., alternate market definitions, regional splits).
8. Supplement with deeper analyses (diversion ratios, entry, efficiencies).
9. Document assumptions and data sources.
10. Prepare narratives to explain whether HHI screening likely over- or under-states competitive concerns.
The bottom line
HHI is a useful, standardized metric for measuring market concentration and is essential for initial antitrust and M&A screening. However, it should not be the sole determinant of competitive effects. Carefully define the market, verify data, run sensitivity checks, and use HHI alongside more detailed economic and factual evidence before drawing firm conclusions.
References and further reading
– Investopedia: “Herfindahl-Hirschman Index (HHI)” (source provided).
– U.S. Department of Justice and Federal Trade Commission, Horizontal Merger Guidelines (2010)
Editor’s note: The following topics are reserved for upcoming updates and will be expanded with detailed examples and datasets.