Herfindahl Index

The Herfindahl Index, often called the HerfindahlHirschman Index (HHI), is a measure of market concentration, which can be defined as the percentage of total industry sales that are contributed by the largest firms in an industry. The HHI is a measure of the size of firms in a given industry and an indicator of the degree of competition in that industry. It is a more sophisticated method of measuring market concentration than the more common method that uses the fourfirm concentration ratio (the percentage of industry sales made by the leading four firms in a given industry). This measure is of interest to antitrust authorities who are trying to determine the impact of a proposed merger on competition in an industry. The formula for calculating the index is shown below.

where the terms in parentheses (Share 1, Share 2, etc.) are the market shares for each firm, the last term (Share n) indicates the market share of the last firm, and the superscript 2 indicates the market share is being squared.

For example, consider an industry consisting of six firms with the following allocation of market shares:

The HHI was first adopted in 1982 by the Reagan administration and is calculated as shown above by squaring the market share of all firms in the market [Page 1066]and summing the squares. The premerger HHI number is then compared with the increase in the HHI that will be caused by a proposed merger. The HHI can vary from 10,000, in the case of a pure monopoly, to a number approaching zero in the case of an atomistic market. If the postmerger HHI is below 1,000, the industry is considered to have low concentration and the merger is unlikely to be challenged. If the postmerger index is between 1,000 and 1,800, the industry is considered to have medium concentration and the merger is likely to be challenged only if the increase is more than 100 points. If the postmerger HHI is above 1,800, the industry is considered to be highly concentrated and the merger is likely to be challenged if the increase is more than 50 points.

An advantage of the HHI is that it gives added weight to the largest companies on the assumption that these firms can exercise greater market control. The index helps differentiate between one industry in which four players have equal shares and another in which one player has a 70% market share and the three others only 10%. The former industry would be more competitive and have a lower HHI index. A disadvantage is that the HHI requires a substantial amount of information in that the market share of every firm in the industry is needed. In practice, however, the smallest firms in an industry can usually be left out of the calculation and this will not make a significant change in the final index.