Herfindahl-Hirschman Index

To judge whether a market is too concentrated, regulators need a single number that captures both how many firms there are and how unequal they are. The Herfindahl-Hirschman Index is that number.

The Herfindahl-Hirschman Index is a measure of market concentration calculated by summing the squared market shares of all the firms in a market. Widely used by competition authorities, it captures in a single figure both the number of competitors and the inequality of their sizes, and it plays a formal role in the assessment of mergers.

Why squaring matters

The distinctive feature of the index is that it squares each firm's share before adding them up. Squaring gives disproportionate weight to the largest firms, so a market dominated by one or two big players scores much higher than one with many firms of similar size, even if a simple count or concentration ratio looked similar. This sensitivity to the distribution of shares, not just their number, is what makes the index more informative than a crude concentration ratio: it reflects the difference between a market of equals and one ruled by a giant.

Reading the numbers

The index ranges from near zero, in a market with many tiny firms approaching perfect competition, up to a maximum representing a pure monopoly with a single firm. Competition authorities use thresholds to classify markets as unconcentrated, moderately concentrated, or highly concentrated, and, crucially, they look at the change in the index that a proposed merger would cause. A merger that raises the index substantially in an already concentrated market is likely to attract scrutiny or challenge, because it signals a meaningful loss of competition.

Uses and limits

The index is valued for being objective, simple to compute, and sensitive to market structure, which is why it is embedded in merger guidelines. But it shares the limits of all concentration measures. It depends entirely on how the market is defined, and drawing the boundaries of a market is often the hardest and most contested step. And, like concentration generally, a high score signals risk rather than proven harm, since a concentrated market may still be competitive or contestable. The index is a screening tool, not a verdict.

The Herfindahl-Hirschman Index distils the structure of a market into a single, structure-sensitive number, and its role in merger assessment makes it one of the most practically consequential measures in competition economics. Its power lies in capturing concentration more faithfully than a simple count, and its limits lie in depending on a market definition that is itself a matter of judgement.