How to Calculate the Herfindahl-Hirschman Index

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The federal government takes a skeptical view of mergers that create, enhance or entrench a company's power over a particular market. The U.S. Department of Justice and the Federal Trade Commission's most recent merger guidelines, issued in 2010, explain how the government evaluates the effects of mergers among competitors. Regulators use various tools, including the Herfindahl-Hirschman Index (HHI) formula, to gauge the effect of mergers on market share.

Market Share Analysis

A company's market share is its percentage of total sales within a market or industry. To calculate the HHI for a proposed merger using the Herfindahl-Hirschman index formula, add the squares of each company's market share. For example, in 2018, Anheuser-Busch InBev held about 41% of the U.S. beer market, and MillerCoors had about 24%. A hypothetical merger of the two would yield a company with an HHI of (41^2 + 24^2) or 2,257 points. A monopoly that controls 100% of an industry's market share will have the maximum HHI value — 10,000 points.

HHI Guidelines Monitor Market Share

The government guidelines create three categories of market share. A market is "unconcentrated" if the post-merger HHI is below 1,500 points. If the HHI range is between 1,500 and 2,500, the market is "moderately concentrated", and scores higher than 2,500 indicate a "highly concentrated" market. In a moderately concentrated market, the government has significant competitive concerns if a potential merger increases the HHI by more than 100 points. The same is true for highly concentrated markets in which the HHI rises by 100 to 200 points.

Market Power Concerns

Federal regulators consider an increase of more than 200 HHI points resulting from a merger in a highly concentrated market as likely to enhance market power. The concern is that the merged company will substantially lessen competition or help create a monopoly. This in turn can lead to higher prices, diminished innovation, reduced output and fewer choices for consumers. The regulating agencies acknowledge that tools such as HHI are predictive and therefore uncertain.

However, the laws barring anticompetitive mergers don't require certainty, only probability. The 2010 guidelines apply only to horizontal mergers, which occur between companies in the same industry. Regulators will begin with the HHI for interpretation of competitiveness within the industry and then continue analysis of a proposed merger.

A Complex Analysis

Although the HHI is an important tool in antitrust enforcement, it would be a mistake to overemphasize its importance. Federal regulators undertake a painstaking analysis of each proposed merger that considers a number of factors, including evidence of anti-competitiveness from previous similar mergers, the ability of the merged company to set discriminatory prices for targeted customers, the number of competitors in a market and the predicted effects the merger will have on product or service innovation.