Herfindahl–Hirschman Index (HHI): A Complete Guide with Illustrations

What is the Herfindahl–Hirschman Index (HHI)?

The Herfindahl–Hirschman Index (HHI) is a widely used measure of market concentration that helps determine the level of competition within an industry. It is commonly used by government regulators, economists, and business analysts to assess whether a market is highly competitive or dominated by a few large firms (oligopoly or monopoly).

---

How is the HHI Calculated?

The HHI is calculated by squaring the market share of each firm in an industry and summing the results.

Formula:

HHI = S₁² + S₂² + S₃² + … + S_n²​

where:

• SiS_iSi​ represents the market share (in percentage) of firm $i$.
• The market shares are squared to give greater weight to larger firms.
• The sum of the squared values gives the HHI score.

---

Understanding HHI with an Example

Let’s assume we have an industry with four firms, and their respective market shares are:

Firm	Market Share (%)
A	40%
B	30%
C	20%
D	10%

Now, we apply the HHI formula:

Applying the HHI formula:

HHI = (40²) + (30²) + (20²) + (10²) = 1600 + 900 + 400 + 100 = 3000

Since HHI = 3000, this indicates a highly concentrated market.

Since HHI = 3000, this indicates a highly concentrated market, meaning competition is limited and a few firms dominate.

---

Interpreting HHI Scores

The U.S. Department of Justice provides guidelines for interpreting HHI values:

HHI Range	Market Concentration Level	Market Type
HHI < 1,500	Low Concentration	Highly Competitive Market
1,500 ≤ HHI < 2,500	Moderate Concentration	Moderately Competitive Market
HHI ≥ 2,500	High Concentration	Oligopoly or Monopoly

---

Illustrating Extreme Cases

1. Highly Competitive Market (HHI is Low)

If there are 10 firms, each with an equal 10% market share:

• HHI = 10 × (10²) = 1,000 → Highly competitive market.

This HHI < 1,500, indicating a highly competitive market.

---

2. Monopoly (HHI is Maximum)

If a single firm dominates the entire market with 100% market share:

• HHI = (100²) = 10,000

This represents a pure monopoly, where one company controls the entire industry.

---

How is HHI Used in Real Life?

1. Antitrust Regulations – Government agencies like the Federal Trade Commission (FTC) and U.S. Department of Justice (DOJ) use HHI to evaluate whether mergers or acquisitions will reduce competition.
2. Business Strategy – Companies use HHI to assess the competitive landscape before entering a new market.
3. Economic Analysis – Researchers use HHI to study industry dynamics and predict pricing behavior.

---

Conclusion

The Herfindahl–Hirschman Index (HHI) is a crucial tool for measuring market concentration. It helps determine if an industry is competitive, moderately concentrated, or highly dominated by a few firms.

• Lower HHI (below 1,500) → Competitive market (many small firms)
• Moderate HHI (1,500 – 2,500) → Some level of dominance (oligopoly)
• High HHI (above 2,500) → Market controlled by a few large firms (monopoly risk)

This index plays a significant role in economic policy, corporate strategy, and regulatory decisions regarding market competition.