HHI

Highlights

• HHI stands for Herfindahl-Hirschman Index, a measure of market concentration.
• Calculates market power by summing the squares of market shares.
• Used by regulators to assess competition and potential monopolies.

The Herfindahl-Hirschman Index (HHI) is a widely used measure of market concentration and competition among firms within an industry. Named after economists Orris C. Herfindahl and Albert O. Hirschman, HHI quantifies the extent of competition by calculating the market power held by individual companies. It is a crucial tool used by antitrust authorities, regulators, and economists to evaluate the impact of mergers, acquisitions, and industry consolidation on market competition. By assessing the distribution of market share among competing firms, HHI helps determine whether an industry is highly competitive, moderately concentrated, or dominated by a few powerful players.

The value of HHI ranges from close to zero to 10,000:

• HHI below 1,500: Indicates a highly competitive industry with many small firms.
• HHI between 1,500 and 2,500: Indicates moderate concentration with some dominant players.
• HHI above 2,500: Indicates high concentration, where a few firms have significant market power.

Significance in Competition Analysis

HHI is an essential tool for assessing market competition, particularly in antitrust and merger analysis. Regulatory authorities, such as the U.S. Department of Justice (DOJ) and the Federal Trade Commission (FTC), use HHI to evaluate the potential impact of mergers and acquisitions on market concentration.

For example, if a proposed merger significantly increases the HHI by more than 200 points in an already concentrated market (HHI above 2,500), regulators may scrutinize the merger for potential anti-competitive effects. Conversely, if the HHI increase is minimal or the industry remains competitive, the merger is less likely to raise antitrust concerns.

Advantages of Using HHI

• Precision and Sensitivity: By squaring the market shares, HHI gives more weight to larger firms, accurately reflecting their influence on market concentration.
• Comprehensive View: It considers the entire market structure, not just the market share of the largest firms.
• Easy to Calculate and Interpret: With readily available market share data, HHI can be calculated easily and provides clear thresholds for assessing competition levels.

Limitations and Criticisms

Despite its widespread use, HHI has certain limitations:

• Lack of Dynamic Analysis: HHI is a static measure that does not account for potential market entry or exit, innovation, or changing competitive dynamics.
• Assumption of Homogeneity: It assumes that all firms within the market are homogeneous, ignoring differences in product differentiation, cost structures, and competitive strategies.
• Ignores Cross-Market Competition: HHI is limited to a single market or industry and may not capture competitive pressures from related markets or substitutes.

Application in Different Industries

HHI is used across various sectors, including technology, telecommunications, finance, and healthcare, to evaluate competitive landscapes and market power dynamics. In technology, for example, HHI is used to assess market concentration in digital platforms, social media, and cloud computing services, where a few dominant players often control significant market shares.

In the banking and financial industry, HHI helps regulators assess the competitive impact of bank mergers, ensuring that no single institution gains disproportionate control over market liquidity or credit availability. Similarly, in the healthcare sector, HHI is used to analyze mergers among hospitals, pharmaceutical companies, and insurance providers to maintain competitive pricing and consumer choice.

Case Study: HHI in Merger Analysis

A well-known example of HHI application is its use in evaluating the merger between AT&T and T-Mobile in 2011. The DOJ used HHI to assess market concentration in the U.S. wireless telecommunications market. At that time, the industry was already concentrated, with four major carriers controlling most of the market share. The merger would have significantly increased the HHI, leading to reduced competition and potential harm to consumers through higher prices and less innovation. As a result, the DOJ opposed the merger, leading to its eventual withdrawal.

Conclusion

The Herfindahl-Hirschman Index (HHI) is a valuable tool for measuring market concentration and assessing competition levels within an industry. By summing the squares of market shares, HHI provides a comprehensive view of market power distribution and is widely used in antitrust and merger analysis. Despite its limitations, such as the lack of dynamic market analysis, HHI remains a critical indicator for regulators and policymakers. It helps them maintain competitive markets, prevent monopolistic behaviors, and protect consumer interests. As industries continue to evolve, especially in the digital age, the relevance of HHI in competition analysis and economic policy will continue to grow.