Herfindahl-Hirschman Index (HHI) Definition, Way, and Example

What Is the Herfindahl-Hirschman Index (HHI)?

The Herfindahl-Hirschman Index (HHI) is a not unusual measure of market center of attention and is used to make a decision market competitiveness, frequently pre- and post-merger and acquisition (M&A) transactions.

The index measures the scale of companies relative to the scale of the trade they are in and the volume of competitiveness. The HHI is calculated thru squaring {the marketplace} percentage of each corporate competing in a market and then summing the following numbers. It may be able to range from as regards to 0 to 10,000, with lower values indicating a far much less concentrated market.

Way and Calculation of the Herfindahl-Hirschman Index (HHI)

The HHI is a many times authorised measure of market center of attention. It is calculated thru squaring {the marketplace} percentage of each corporate competing in a market and then summing the following numbers. It may be able to range from as regards to 0 to 10,000. The U.S. Department of Justice uses the HHI for evaluating possible merger antitrust issues.

$\begin{array}{cc}& HHI=s_1^2+s_2^2+s_3^2+\dots s_n^2\\ & \text{where:}\\ & s_n=\text{the market percentage percentage of corporate }n\\ & \text{ expressed as a entire amount, no longer a decimal}\end{array}$

get started{aligned}&HHI=s^2_1+s^2_2+s^2_3+dots s^2_n&textbf{where:}&s_n=text{{the marketplace} percentage percentage of firm } n& qquad,text{ expressed as an entire amount, no longer a decimal}end{aligned} ​HHI=s12​+s22​+s32​+…sn2​where:sn​=the market percentage percentage of corporate n expressed as a entire amount, no longer a decimal​

What the Herfindahl-Hirschman Index (HHI) Indicates

The closer a market is to a monopoly, the higher {the marketplace}’s center of attention (and the lower its competition). If, for example, there were only one corporate in an trade, that corporate would have 100% market percentage, and the HHI would an identical 10,000, indicating a monopoly. If there were thousands of businesses competing, each would have more or less 0% market percentage, and the HHI will also be as regards to 0, indicating near to best competition.

The U.S. Department of Justice considers a market with an HHI of not up to 1,500 to be a competitive marketplace, an HHI of 1,500 to 2,500 to be a slightly concentrated marketplace, and an HHI of 2,500 or upper to be a very concentrated marketplace. As a typical rule, mergers that build up the HHI thru more than 200 problems in extraordinarily concentrated markets elevate antitrust problems, as they are assumed to support market power beneath Section 5.3 of the Horizontal Merger Guidelines jointly issued in the course of the Justice Department and the Federal Trade Charge (FTC).

The primary advantage of the HHI is the simplicity of the calculation needed to make a decision it and the small amount of information required for the calculation. The primary problem of the HHI stems from the fact that it is such a simple measure that it fails to bear in mind the complexities of rather numerous markets one way or the other that allows for a in reality right kind analysis of competitive or monopolistic market necessities.

Example of the Herfindahl-Hirschman Index (HHI)

The HHI is calculated thru taking {the marketplace} percentage of each corporate inside the trade, squaring them, and summing the end result, as depicted inside the equation above. Believe the following hypothetical trade with 4 general corporations:

1. Corporate 1 market percentage = 40%
2. Corporate 2 market percentage = 30%
3. Corporate 3 market percentage = 15%
4. Corporate 4 market percentage = 15%

The HHI is calculated as:

$\begin{array}{cc}HHI& =40^2+30^2+15^2+15^2\\ & =1,600+900+225+225=2,950\end{array}$

get started{aligned}HHI &= 40^2 + 30^2 + 15^2 + 15^2 &= 1,600 + 900 + 225 + 225 = 2,950end{aligned} HHI​=402+302+152+152=1,600+900+225+225=2,950​

This HHI value is considered a very concentrated trade, as expected because of there are most simple 4 corporations. Then again, the selection of corporations in an trade does no longer necessarily indicate the rest about market center of attention, which is why calculating the HHI is important.

For instance, assume an trade has 20 corporations. Corporate 1 has a market percentage of 48.59%, and each of the 19 closing corporations has a market percentage of 2.71% each. The HHI will also be exactly 2,500, indicating a significantly extraordinarily concentrated market. If Corporate 1 had a market percentage of 35.82% and each of the rest corporations had a 3.38% market percentage, the HHI will also be exactly 1,500, indicating a competitive marketplace.

Obstacles of the Herfindahl-Hirschman Index (HHI)

The basic simplicity of the HHI carries some inherent disadvantages, mainly in the case of failing to stipulate the correct market that is being examined in a right kind, actual taking a look manner. For instance, imagine a situation by which the HHI is used to evaluate an trade made up our minds to have 10 full of life companies, and each company has a few 10% market percentage. Using the elemental HHI calculation, the trade would appear extraordinarily competitive.

Then again, during the marketplace, one company would most likely have as much as 80% to 90% of the business for a decided on phase of {the marketplace}, such for the reason that sale of one specific products. That corporate would thus have near to an entire monopoly for the producing and sale of that product.

Every other problem in defining a market and taking into account market percentage can get up from geographic components. This problem can occur when companies inside an trade have more or less an identical market percentage, on the other hand they each carry out most simple specifically areas of the country, so that each corporate, in have an effect on, has a monopoly during the specific marketplace by which it does business.

For instance, while the merger of cell phone providers Sprint and T-Cellular upper the HHI value for all of the country thru quite a few hundred problems because of market percentage is concentrated in certain geographical areas, the index value upper thru more than 1,000 problems in a number of markets. For the ones reasons, for the HHI to be as it should be used, other components must be regarded as, and markets must be very clearly defined.

Creators of the Herfindahl-Hirschman Index (HHI)

The idea that that behind the HHI to start with emerged in a 1945 e book thru German economist Albert O. Hirschman titled National Power and the Building of Global Trade. The method proposed thru Hirschman differed from provide measures of center of attention thru hanging a additional essential weighting on better corporations whose upper market percentage has a greater impact on the stage of competitiveness to be had available in the market.

A few years after Hirschman outlined this system for measuring market center of attention, American economist Orris C. Herfindahl repurposed the idea in his 1950 doctoral dissertation, Focal point inside the U.S. Steel Business. Whilst Hirschman had performed the idea to the point of interest of imports and exports on a countrywide basis, Herfindahl uses the framework to analyze on the competitiveness of the steel trade. Herfindahl refers to Hirschman’s art work in a footnote.

The Bottom Line

The Herfindahl-Hirschman Index (HHI) is used to make a decision market competitiveness. It measures the extent of center of attention inside of of a chosen market. A market with an HHI of not up to 1,500 is considered a competitive marketplace, an HHI of 1,500 to 2,500 is slightly concentrated, and an HHI of 2,500 or upper is terribly concentrated.