A standard way of indicating the degree of concentration of an industrial sector. HHI is calculated by summing the square of the market shares of the market participants, usually expressed as a percentage rather than as a decimal. Thus for a given market, it can be expressed
HHIPre-Merger = SA2 + SB2 + SC2 + SD2 + SE2 etc.
The maximum possible HHI, one where 100 percent of the market is held by a single monopolist is 10,000, while for example a market with ten participants each with a 10 percent market share would have an HHI of 1,000 (and would be regarded as beginning to be an oligopoly.) If a merger occurs between say, participant A and participant B, the HHI would then be recalculated thus
HHIPost-Merger = (SA + SB)2 + SC2 + SD2 + SE2 etc.
HHI is used in particular by United States Antitrust Division and United States Federal Trade Commission as an econometric measure of whether a merger is unduly concentrative. In particular the new Horizontal Merger Guidelines issued in 2010 set certain criteria for market concentration and allowable mergers, including mergers notified under the Hart-Scott-Rodino Act. Where the post-merger HHI will be below 1,500 the agencies will regard the market as un-concentrated and the merger is unlikely to attract further scrutiny. Where the post merger HHI is between 1,500 and 2,500 the market is regarded as moderately concentrated and mergers that cause a change in the HHI of more than 100 would normally attract close scrutiny. Where the post merger HHI is more than 2,500 the market is regarded as highly concentrated and mergers that raise the HHI by 50 will attract close scrutiny and those raising it by 100 would be regarded as likely to have anticompetitive consequences. The 2010 guidelines are considerably more lax than the older 1992/97 Guidelines which set the thresholds as un-concentrated below 1000 and moderately concentrated below 1,800.
The EU Horizontal Merger Guidelines (2004 OJ C 31/5) set forth slightly different HHI criteria. Where the post merger HHI is below 1,000, the European Commission regards significant analysis of the merger as usually unnecessary. Also, in general, where the post-merger HHI will be less than 2,000 and the merger caused a change in HHI of less than 250, or the HHI will be more than 2,000 but the change was less than 150, the Commission will normally not engage in significant analysis, except under certain circumstances such as: one of the merging companies is a new or potential entrant with an as yet small market share; one of the parties is a major innovator; there are significant cross shareholdings between market participants or the target company is regarded as an industry “maverick”; there is reason to believe that cartels have existed in the sector in the past; or the acquirer already has a 50 percent market share.
The problem with HHI as a measure is that it depends on what one defines as the relevant market. Take, for example, the market for certain fruit—if it is defined as say the supply of pears, the market might prove highly concentrated; if it is defined as the market for hard fruit (e.g., apples and pears), moderately concentrated; if defined as all fruit, un-concentrated. Arguably a merger of two of a small number of pear suppliers might result in a highly concentrated market, but if one were to regard apples as a substitute for pears, it would result in only a moderately concentrated market, while if oranges were added as a substitute, the market would be hardly concentrated at all. Much of the economists battle in complex mergers lies in addressing this issue of market definition and what are viable substitutes.
The origin of HHI lies with two economists, who working separately, developed a similar mathematical measure of concentration, which was subsequently dubbed with both of their names. Orris Clement Herfindahl was an agricultural economist (and noted ecologist) who developed his version of the index in 1952 at the University of Chicago while studying concentration in the steel industry. Herfindahl died in 1972 while trekking in Nepal. Albert O. Hirschman, a more prolific author, and German born member of the French Resistance in WW II (where he helped smuggled thousands out of Nazi reach, including Marc Chagall, Marcel Duchamp and Hannah Arendt), was a member of the Institute for Advanced Study at Princeton University; he died in 2012.