Identify the
market shares of all firms in the industry.
Square each firm's market share.
Sum all the squared market shares to get the HHI.
For example, if an industry has four firms with market shares of 30%, 30%, 20%, and 20%, the HHI would be calculated as follows:
HHI = 302 + 302 + 202 + 202 = 900 + 900 + 400 + 400 = 2600.
Merger analysis: Regulators often use HHI to evaluate the potential impact of mergers and acquisitions on market concentration. A significant increase in HHI post-merger may indicate reduced competition.
Antitrust investigations: High HHI values can trigger antitrust scrutiny to ensure no single firm can dominate the market and restrict competition.
Market strategy: Firms use HHI to gauge the level of competition and devise strategies to enhance their market share or enter new markets.
What are the Thresholds for HHI?
The U.S. Department of Justice and the Federal Trade Commission have established specific thresholds for HHI to assess market concentration levels:
HHI below 1500: Indicates a
competitive market with low concentration.
HHI between 1500 and 2500: Reflects a moderately concentrated market.
HHI above 2500: Signifies a highly concentrated market, often prompting regulatory concern.
Limitations of HHI
While the HHI is a valuable tool, it has certain limitations: Ignores market dynamics: HHI does not account for
market dynamics such as potential entry of new firms or technological changes that could alter market shares.
Assumes static market shares: The index assumes that market shares remain constant, which may not be realistic in rapidly evolving industries.
Lacks granularity: HHI provides an overall measure of concentration but does not offer detailed insights into the competitive behavior of individual firms.
Conclusion
In summary, the
Herfindahl-Hirschman Index is a pivotal metric in the realm of business for measuring market concentration and assessing competition levels. While it has its limitations, it remains an essential tool for regulators and businesses to maintain a competitive and fair market environment.