The Herfindahl-Hirshman Index
The Herfindahl-Hirshman Index
A four-firm concentration ratio is a simple tool, which may reveal only part of the story. For example, consider two industries that both have a four-firm concentration ratio of 80. However, in one industry five firms each control 20% of the market, while in the other industry, the top firm holds 77% of the market and all the other firms have 1% each. Although the four-firm concentration ratios are identical, it would be reasonable to worry more about the extent of competition in the second case—where the largest firm is nearly a monopoly—than in the first.
Another approach to measuring industry concentration that can distinguish between these two cases is called the Herfindahl-Hirschman Index (HHI). The HHI, as it is often called, is calculated by summing the squares of the market share of each firm in the industry, as the following Work it Out shows.
Calculating HHI
Step 1. Calculate the HHI for a monopoly with a market share of 100%. Because there is only one firm, it has 100% market share. The HHI is 1002 = 10,000.
Step 2. For an extremely competitive industry, with dozens or hundreds of extremely small competitors, the value of the HHI might drop as low as 100 or even less. Calculate the HHI for an industry with 100 firms that each have 1% of the market. In this case, the HHI is 100(12) = 100.
Step 3. Calculate the HHI for the industry shown in this table. In this case, the HHI is 162 + 102 + 82 + 7(62) + 8(32) = 744.
Step 4. Note that the HHI gives greater weight to large firms.
Step 5. Consider the example given earlier, comparing one industry where five firms each have 20% of the market with an industry where one firm has 77% and the other 23 firms have 1% each. The two industries have the same four-firm concentration ratio of 80. But the HHI for the first industry is 5(202) = 2,000, while the HHI for the second industry is much higher at 772 + 23(12) = 5,952.
Step 6. Note that the near-monopolist in the second industry drives up the HHI measure of industrial concentration.
Step 7. Review this table which gives some examples of the four-firm concentration ratio and the HHI in various U.S. industries in 2009. (You can find market share data from multiple industry sources. Data in the table are from: Verizon (for wireless), The Wall Street Journal (for automobiles), IDC Worldwide (for computers) and the U.S. Bureau of Transportation Statistics (for airlines).)
Examples of Concentration Ratios and HHIs in the U.S. Economy, 2009
| U.S. Industry | Four-Firm Ratio | HHI |
|---|---|---|
| Wireless | 91 | 2,311 |
| Largest five: Verizon, AT&T, Sprint, T-Mobile, MetroPCS | ||
| Automobiles | 63 | 1,121 |
| Largest five: GM, Toyota, Ford, Honda, Chrysler | ||
| Computers | 74 | 1,737 |
| Largest five: HP, Dell, Acer, Apple, Toshiba | ||
| Airlines | 44 | 536 |
| Largest five: Southwest, American, Delta, United, U.S. Airways |
In the 1980s, the FTC followed these guidelines: If a merger would result in an HHI of less than 1,000, the FTC would probably approve it. If a merger would result in an HHI of more than 1,800, the FTC would probably challenge it. If a merger would result in an HHI between 1,000 and 1,800, then the FTC would scrutinize the plan and make a case-by-case decision. However, in the last several decades, the antitrust enforcement authorities have moved away from relying as heavily on measures of concentration ratios and HHIs to determine whether a merger will be allowed, and instead carried out more case-by-case analysis on the extent of competition in different industries.
This lesson is part of:
Monopoly and Antitrust Policy