Herfindahl Index

Written By
Paul Tracy
Updated July 6, 2021

What is the Herfindahl Index?

Also known as the Herfindahl-Hirschman Index (HHI), Herfindahl Index measures the market concentration of an industry's 50 largest firms. The purpose is to determine whether the industry is competitive or nearing a monopoly.

Why Does the Herfindahl Index Matter? 

It’s important for industry analysts to understand where a particular company's source of growth and competitive advantage comes from (and competition structure is one of the main components of this analysis). 

For example, if a company exists in a highly competitive industry, it will be more difficult for it to maintain above-average profit margins in the future – even if it currently has above-average profit margins.

Herfindahl Index Formula

You can calculate Herfindahl Index by squaring the market share for each firm (up to 50 firms) and then adding the squares.

In a perfectly competitive market, HHI should approach zero. Let's say there are thousands of restaurants in your city, but the top 50 each have 0.1% of the market share. The HHI is 0.12 x 50 = 0.5.

HHI Example

Let's say there are four grocery stores in your town: Albert's, Bob's, Carl's and Donald's. Their market share is broken down as follows:

HHI calculation

To calculate the HHI, you would apply the following formula: 

HHI = 502 + 252 + 152 + 102 = 3,450
 

What Is the HHI for a Monopoly?

In a monopoly, HHI approaches 10,000. If the largest firm has 100% of the market share, HHI = 1002 = 10,000.

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All of our content is verified for accuracy by Paul Tracy and our team of certified financial experts. We pride ourselves on quality, research, and transparency, and we value your feedback. Below you'll find answers to some of the most common reader questions about Herfindahl Index.

How Does the Justice Department Use HHI? 

The Justice Department uses the Herfindahl Index to decide whether certain mergers are good for competition in the marketplace. A market with an HHI under 1,000 is considered competitive. The Justice Department is likely to scrutinize a merger in an industry with a post-merger HHI of between 1,000 and 1,800, and it is almost certain to outright reject approval for mergers that result in a post-merger HHI which exceed 1,800. 
 

Paul has been a respected figure in the financial markets for more than two decades. Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 3 million monthly readers.

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