Herfindahl-Hirschman Index - HHI

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What is the 'Herfindahl-Hirschman Index - HHI'

The Herfindahl-Hirschman index (HHI) is a commonly accepted measure of market concentration. It is calculated by squaring the market share of each firm competing in a market, and then summing the resulting numbers, and can range from close to zero to 10,000. The U.S. Department of Justice uses the HHI for evaluating potential mergers issues.

BREAKING DOWN 'Herfindahl-Hirschman Index - HHI'

The closer a market is to being a monopoly, the higher the market's concentration (and the lower its competition). If, for example, there were only one firm in an industry, that firm would have 100% market share, and the HHI would equal 10,000, indicating a monopoly. If, there were thousands of firms competing, each would have nearly 0% market share, and the HHI would be close to zero, indicating nearly perfect competition.

The U.S. Department of Justice considers a market with an HHI of less than 1,500 to be a competitive marketplace, an HHI of 1,500 to 2,500 to be a moderately concentrated marketplace, and an HHI of 2,500 or greater to be a highly concentrated marketplace. As a general rule, mergers that increase the HHI by more than 200 points in highly concentrated markets raise antitrust concerns, as they are assumed to enhance market power under the section 5.3 of the Horizontal Merger Guidelines jointly issued by the department and the Federal Trade Commission.

Herfindahl-Hirschman Index Example Calculations

The HHI is calculated by taking the market share of each firm in the industry, squaring them, and summing the result:

HHI = s1^2 + s2^2 + s3^2 + ... + sn^2 (where s is the market share of the each firm expressed as a whole number, not a decimal)

Consider the following hypothetical industry with four total firms:

Firm one market share = 40%

Firm two market share = 30%

Firm two market share = 15%

Firm two market share = 15%

The HHI is calculated as:

HHI = 40^2 + 30^2 + 15^2 + 15^2 = 1,600 + 900 + 225 + 225 = 2,950

This is considered a highly concentrated industry, as expected since there are only four firms. But the number of firms in an industry does not necessarily indicate anything about market concentration, which is why calculating the HHI is important. For example, assume an industry has 20 firms. Firm one has a market share of 48.59% and each of the 19 remaining firms have a market share of 2.71% each. The HHI would exactly 2,500, indicating a highly concentrated market. If firm number one had a market share of 35.82% and each of the remaining firms had 3.38% market share, the HHI would be exactly 1,500, indicating a competitive market place.