Herfindahl-Hirschman Index (HHI)

What Is the Herfindahl-Hirschman Index (HHI)?

The Herfindahl-Hirschman Index (HHI) is a common measure of market concentration and is utilized to decide market competitiveness, frequently pre-and post-merger and acquisition (M&A) transactions.

Formula and Calculation of 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 contending in a market and afterward adding the subsequent numbers. It can go from close to zero to 10,000. The U.S. Department of Justice involves the HHI for assessing potential merger issues.
$\begin&HHI=s2_1+s2_2+s2_3+\dots s2_n\&\textbf\&s_n=\text n\& \qquad,\text{ expressed as a whole number, not a decimal}\end$

What the Herfindahl-Hirschman Index (HHI) Can Tell You

The closer a market is to a monopoly, the higher the market's concentration (and the lower its competition). If, for instance, there were just a single firm in an industry, that firm would have 100% market share, and the Herfindahl-Hirschman Index (HHI) would rise to 10,000, demonstrating a monopoly. On the off chance that there were great many firms contending, each would have generally 0% market share, and the HHI would be close to zero, showing almost perfect competition.

The U.S. Department of Justice considers a market with a HHI of under 1,500 to be a competitive marketplace, a HHI of 1,500 to 2,500 to be a respectably focused marketplace, and a HHI of 2,500 or greater to be an exceptionally thought marketplace. When in doubt, mergers that increase the HHI by in excess of 200 points in exceptionally focused markets raise antitrust worries, as they are assumed to improve market power under section 5.3 of the Horizontal Merger Guidelines jointly issued by the department and the Federal Trade Commission (FTC).

The primary advantage of the Herfindahl-Hirschman Index (HHI) is the simplicity of the calculation important to decide it and the small amount of data required for the calculation. The primary disadvantage of the HHI originates from the way that it is such a simple measure that it neglects to consider the intricacies of different markets in a manner that takes into account a truly accurate assessment of competitive or monopolistic market conditions.

Regulators utilize the HHI Index involving the 50 biggest companies in a specific industry to decide whether that industry ought to be viewed as competitive or as close to being a monopoly.

Illustration of the Herfindahl-Hirschman Index (HHI)

The HHI is calculated by taking the market share of each firm in the industry, squaring them, and adding the outcome, as portrayed in the equation above. Think about the accompanying speculative industry with four total firms:

1. Firm one market share = 40%
2. Firm two market share = 30%
3. Firm three market share = 15%
4. Firm four market share = 15%

The HHI is calculated as:
$\beginHHI &= 402 + 302 + 152 + 152\ &= 1,600 + 900 + 225 + 225 = 2,950\end$
This HHI value is viewed as an exceptionally focused industry, true to form since there are just four firms. Be that as it may, the number of firms in an industry doesn't be guaranteed to show anything about market concentration, which is the reason working out the HHI is important.

For instance, expect an industry has 20 firms. Firm one has a market share of 48.59% and every one of the 19 excess firms has a market share of 2.71% each. The HHI would be precisely 2,500, showing a substantially exceptionally thought market. On the off chance that firm number one had a market share of 35.82% and every one of the leftover firms had a 3.38% market share, the HHI would be precisely 1,500, showing a competitive marketplace.

Limitations of the Herfindahl-Hirschman Index (HHI)

The fundamental simplicity of the HHI conveys a few inherent disadvantages, essentially in terms of neglecting to characterize the specific market that is being analyzed in a legitimate, sensible way. For instance, consider a situation where the HHI is utilized to assess not entirely set in stone to have 10 active companies, and each company has about a 10% market share. Utilizing the essential HHI calculation, the industry would show up exceptionally competitive.

Be that as it may, inside the marketplace, one company could have as much as 80% to 90% of the business for a specific segment of the market, like the sale of one specific thing. That firm would consequently have almost a total monopoly for the production and sale of that product.

One more problem in characterizing a market and taking into account market share can emerge from geographic factors. This problem can happen when there are companies inside an industry that have generally equivalent market share, however they each operate just in specific areas of the country, so that each firm, in effect, includes a monopoly inside the specific marketplace where it carries on with work.

For instance, while the merger of Sprint and T-Mobile will increase the HHI value for the whole country by several hundred points since market share is moved in certain geographical areas, the index value would increase by in excess of 1,000 points in many markets. Hence, for the HHI to be appropriately utilized, different factors must be thought about, and markets must be obviously defined.

Features

• The primary disadvantage of the HHI originates from the way that it is such a simple measure that it neglects to consider the intricacies of different markets.
• A market with a HHI of under 1,500 is viewed as a competitive marketplace, a HHI of 1,500 to 2,500 is decently thought, and a HHI of 2,500 or greater is exceptionally focused.
• The Herfindahl-Hirschman Index (HHI) is utilized to decide market competitiveness.

FAQ

What Does the Herfindahl-Hirschman Index (HHI) Mean?

The Herfindahl-Hirschman Index (HHI) is a common measure of market concentration and is utilized to decide market competitiveness, frequently pre-and post-M&A transactions. The closer a market is to a monopoly, the higher the market's concentration (and the lower its competition).

How Is Market Concentration Defined?

A market with a HHI of under 1,500 is viewed as a competitive marketplace, a HHI of 1,500 to 2,500 is modestly thought, and a HHI of 2,500 or greater is profoundly focused. When in doubt, mergers that increase the HHI by in excess of 200 points in profoundly focused markets raise antitrust worries, as they are assumed to improve market power.

What Is the Main Advantage of the Herfindahl-Hirschman Index (HHI)?

The primary advantage of the Herfindahl-Hirschman Index (HHI) is the simplicity of the calculation and the small amount of data required for the calculation. Additionally, firms are weighted by their size, which makes the HHI better than different measures, similar to the concentration ratio.