Definition
The Herfindahl-Hirschman Index (HHI) is a commonly accepted measure of market concentration. It’s calculated by squaring the market share of each firm competing in a market and then summing the resulting numbers. The index can range from close to zero, indicating a highly competitive market, to 10,000, indicating a highly concentrated, monopolistic market.
Phonetic
The phonetics for the term “Herfindahl-Hirschman Index (HHI)” would be approximately : “ɜr-ˈfin-dəl ˈhɪrʃ-mən ˈɪn-deks (HHI)”
Key Takeaways
1. Definition and Use: The Herfindahl-Hirschman Index (HHI) is a measure of market concentration. It is used by economists and government organizations to evaluate the potential impact of mergers on the competitiveness of an industry. The higher the HHI, the more concentrated the industry and the less competition exists.
2. Calculation: The index is calculated by squaring the market share of each firm in the industry and then summing the resultant numbers. The HHI can range from zero to 10,000. If there’s only one firm in the industry, the HHI would be 10,000, signifying a monopoly. If, for example, there are a large number of firms each with a market share close to 0, the HHI will approach zero, signifying perfect competition.
3. Implications on Market Structure: The Herfindahl-Hirschman Index (HHI) is a powerful tool to determine the market structure. Markets with an HHI of less than 1,500 are typically classified as competitive, those between 1,500 and 2,500 are considered moderately concentrated, and those above 2,500 are deemed highly concentrated. Hence, examining the HHI of different markets can aid in a better understanding of their structural features and competition levels.
Importance
The Herfindahl-Hirschman Index (HHI) is a crucial tool in the business and finance world as it is widely used to measure market concentration and evaluate the potential anti-competitive effects of mergers and acquisitions. By calculating the sum of the squares of the market shares of all firms within a specific industry, the HHI provides a numerical representation of market competition. Higher HHI values indicate less competition and potential monopoly-like conditions, posing risks for consumer welfare. Regulatory bodies such as the Department of Justice often use the HHI in antitrust investigations to prevent the development of monopolistic dynamics, and thus it plays a fundamental role in promoting and maintaining a healthy marketplace.
Explanation
The purpose of the Herfindahl-Hirschman Index (HHI) is to measure the concentration in an industry or market, providing valuable insights into the competitiveness of the sector. This metric offers a quantitative tool for competition authorities and policymakers to understand the degree of concentration among firms in a market, thereby aiding in decisions related to market regulation, business mergers, and acquisitions. Higher values of HHI indicate higher market concentration, hinting at a monopoly or oligopoly, while lower values suggest a more competitive environment.In addition, the HHI is often used by competition authorities to assess and manage anti-trust issues. For instance, if a proposed merger significantly increases the HHI, suggesting greater concentration and decreased competition in the market, it might be blocked to protect consumers from potential price exploitation. Similarly, financial institutions may also use HHI to assess investment portfolios’ concentration risk and diversify their investments accordingly.
Examples
1. Telecommunications Industry: The AT&T initial plan to acquire T-Mobile in 2011 was rejected based on a high HHI score, indicating that the merger would lead to a significant increase in the concentration and lower the competition in the telecommunications market. The Federal Communications Commission (FCC) used the Herfindahl-Hirschman Index to assess the competitive impact of the proposed merger, which led to its eventual cancellation.2. Beer Industry: According to the Brewer’s Almanac, the HHI for the American beer industry in 2010 was over 2700, signifying a highly concentrated market. Most of this was due to two key players, Anheuser-Busch InBev and MillerCoors, controlling a significant percentage of the total market.3. Health Insurance Industry: In 2016, the U.S. Department of Justice (DOJ) blocked two major health insurance mergers: Anthem’s proposed acquisition of Cigna and Aetna’s proposed acquisition of Humana. The DOJ used the Herfindahl-Hirschman Index to determine that these mergers would lead to an unacceptable level of market concentration, reducing competition and potentially increasing prices for consumers.
Frequently Asked Questions(FAQ)
What is the Herfindahl-Hirschman Index (HHI)?
The Herfindahl-Hirschman Index (HHI) is a commonly accepted measure of market concentration. It’s calculated by squaring the market share of each firm competing in the market and then summing the resulting numbers. It is used by various governments to review potential mergers and acquisitions.
How is the HHI calculated?
The HHI is calculated by squaring the market share of each firm competing in the market and then summing the resulting numbers. The formula is HHI = ∑(si)^2 where si is the market share of each firm in the market.
What does a high HHI indicate?
A high HHI score generally indicates a high level of market concentration, meaning fewer firms control the majority of the market’s total output or sales. It is often considered a sign of less competition.
What does a low HHI score imply?
A low HHI score indicates a larger number of smaller firms with a lower level of concentration. This usually implies a more competitive market environment.
Why is the HHI used instead of the simple percentage of market share?
The HHI provides a more comprehensive view of a market’s competitive landscape by taking into account not only the largest firm’s market share but also the combined market share of all firms typically to measure the competition level.
How does the government use the HHI in antitrust proceedings?
Regulators use the HHI to assess the potential impact of mergers or acquisitions on market concentration. If a proposed merger substantially increases the HHI, it may be deemed as potentially anticompetitive and could be blocked or subjected to conditions.
What are the HHI thresholds used by authorities to determine market competition?
According to the U.S. Department of Justice, a market with an HHI of less than 1,500 is considered to be a competitive marketplace, an HHI of 1,500 to 2,500 is considered to be a moderately concentrated marketplace, and an HHI of 2,500 or greater is considered to be a highly concentrated marketplace.
Can the HHI be used to assess competition across different industries?
Yes, it can. However, it’s crucial to understand that factors driving competition can differ significantly across industries. Thus, while the HHI can provide a useful snapshot of market concentration, it should be supplemented with other industry-specific analyses.
Related Finance Terms
- Market Concentration
- Antitrust Regulations
- Mergers and Acquisitions (M&A)
- Competition Law
- Monopoly Power
Sources for More Information
