Herfindahl-Hirschman Index Defined
The Herfindahl-Hirschman Index (HHI), also shortened to Herfindahl Index is a commonly accepted method of measurement of market concentration as a means to ascertain whether competitiveness exists within an industry or if market monopoly has set in. More often than not, the Herfindahl-Hirschman Index measures market concentration of the top 50 companies of an industry.
Economists calculate the Herfindahl-Hirschman Index (HHI) in an industry by squaring the market share of competing firms pertaining to that particular industry and then adding up the squares. The index is measured in points – any value above zero and up to 10,000 points is an acceptable value for the HHI.
A Little More on the Herfindahl-Hirschman Index
Market monopoly stems from high market concentration and a significant reduction of competition. Any firm that has a monopoly in the market will have an HHI close to 10,000; in case the firm is the only player in its industry segment, it will have a 100% market share and thus, an HHI of 10,000. Conversely, if there were several thousand competing firms in an industry, each firm would have virtually 0% market share. In such an instance, the HHI would approach zero, signifying a scenario of perfect competition.
According to the U.S. Department of Justice, any industry with an HHI below 1,500 is considered a competitive industry. Similarly, an HHI value between 1,500 and 2,500 denotes a moderately concentrated industry. Finally, an industry with an HHI of 2,500 or more is designated a highly concentrated industry. Generally, any merger that raises the the Herfindahl-Hirschman Index by more than 200 points in extremely concentrated markets renders it vulnerable to antitrust issues.
Herfindahl-Hirschman Index Example Calculations
The Herfindahl-Hirschman Index is calculated by squaring the market share of competing firms and then adding up the squares:
HHI = (market share 1)² + (market share 2)²+ (market share 3)² + … + (market share n)² , market share values with decimals being rounded off as whole numbers
Let us suppose there are four footwear manufacturers in an industry:
Manufacturer 1 market share = 30%
Firm two market share = 26%
Firm three market share = 24%
Firm four market share = 20%
The HHI calculation is as follows:
HHI = 30² + 26² + 24² + 20² = 900 + 676 + 576 + 400 = 2,552
In the above example, while the presence of only four firms in an industry anyhow depicts a highly concentrated industry, this depiction is reinforced by the HHI value of 2,552, which, according to the U.S. Department of Justice, corresponds to a highly concentrated industry. The HHI thus comes across as an invaluable and reliable index to measure market concentration.