Herfindahl–Hirschman index

Named after economists Orris C. Herfindahl and Albert O. Hirschman, it is an economic concept widely applied in competition law, antitrust regulation,[1] and technology management.

[2] HHI has continued to be used by antitrust authorities, primarily to evaluate and understand how mergers will affect their associated markets.

As such, it can range from 0 to 1.0, moving from a huge number of very small firms to a single monopolistic producer.

The major benefit of the Herfindahl index in relation to measures such as the concentration ratio is that the HHI gives more weight to larger firms.

[8] As can be seen prior to the merger, the HHI, while not low, is in a range that allows for strong competition.

[8] This demonstrates how the HHI enables antitrust authorities to understand the impact that mergers have on the market.

An HHI below 0.01 (or 100) indicates a highly competitive industry, Mergers and acquisitions with an increase of 100 points or less will usually not have any anti competitive effects and will require no further analysis.

Mergers and acquisitions between 100 and 1500 points are unlikely to have anti-competitive effects and will most likely not need further analysis.

Mergers and acquisitions that result in moderate market concentration from HHI increases will raise anti-competitive concerns and will require further analysis.

[10] Mergers and acquisitions with HHI scores of 2,500 or above will be considered anti competitive and an in-depth analysis produced, if the scores are well above 2,500 they are considered to enhance market power they may only be allowed to progress when significant evidence is shown that the merger or acquisition will not increase market power.

[10] A small index indicates a competitive industry with no dominant players.

Using case 2, we find that the market structure is equivalent to having 1.55521 firms of the same size.

It is computed as: where again, N is the number of firms in the market, and HHI is the usual Herfindahl Index, as above.

Using the normalized Herfindahl index, information about the total number of players (N) is lost, as shown in the following example: Assume a market with two players and equally distributed market share;

Now compare that to a situation with three players and again an equally distributed market share;

Thus, the normalized Herfindahl index can serve as a measure for the equality of distributions, but is less suitable for concentration.

The usefulness of this statistic to detect monopoly formation is directly dependent on a proper definition of a particular market (which hinges primarily on the notion of substitutability).

The index fails to take into consideration the complex nature of the market being tested.

[11] The United States federal anti-trust authorities such as the Department of Justice and the Federal Trade Commission use the Herfindahl index as a screening tool to determine whether a proposed merger or acquisition is likely to raise antitrust concerns.

[4] However, these indices scores are not rigid guidelines that must be followed, while high levels of concentration is concerning, they indices scores provide ways to identify which mergers and acquisitions are potentially noncompetitive.

There are other factors that need to be considered that will either help reinforce or counter the harmful effects of higher market concentration.

The Herfindahl-Hirschman index is used as a starting point to gauge initial market power and then determine if additional information is needed to conduct further analysis on any potential anti-competitive concerns.

In the more general case of unequal market share, 1/H is called "equivalent (or effective) number of firms in the industry", Neqi or Neff.

A higher Herfindahl signifies a less competitive (i.e., more concentrated) industry.

It can be shown that the Herfindahl index arises as a natural consequence of assuming that a given market's structure is described by Cournot competition.

The Herfindahl index is also a widely used metric for portfolio concentration.

[16] In portfolio theory, the Herfindahl index is related to the effective number of positions

is computed as the sum of the squares of the proportion of market value invested in each security.

[18] It may also be used as a constraint to force a portfolio to hold a minimum number of effective assets:

If all firms have equal (identical) shares (that is, if the market structure is completely symmetric, in which case