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HHI (Herfindahl-Hirschman Index) is a commonly used method of measuring the concentration of an industry
in a particular geographic market. HHI is calculated by squaring the market share of each firm competing
in the market and then summing these results. This sum can range from 0 to 10000, with larger numbers
signifying more concentrated markets. That is:
Thus, if there were only one firm in a market—that is, the firm controlled 100 percent of the market—the HHI for this market would be 10,000 (= 1002 ).
Most markets, however, have several firms, and often many firms, competing with each other. HHI, by using the square of each firm’s market share in its calculation, accounts for all firms in the market, giving greater weight to firms with larger market shares.
For example, if a market has five firms competing in it, with one of the firms controlling 35 percent of the market, one controlling 25 percent of the market, one controlling 20 percent, one controlling 15 percent and the last controlling 5 percent, then:
HHI = (35)2 + (25)2 + (20)2 + (15)2 + (5)2 = 2,500
If, instead, each firm controls 20 percent of the market, then:
HHI = (20)2 + (20)2 + (20)2 + (20)2 + (20)2 = 2,000
Thus, even though there are five firms in both examples, the market in the first example is more concentrated than the market in the second. More generally, as firms’ market shares become relatively more equal, or as the number of firms competing in a market increases, the lower that market’s HHI will be.
HHI is an index used to measure an industry's concentration in a geographic market. The U.S. Department of Justice (DOJ) has set forth bank merger guidelines for determining if a market is considered to be unconcentrated, moderately concentrated or highly concentrated based on the market's HHI.
The guidelines are as follows:
A pro forma HHI analysis considers how a market's HHI changes when the market's structure changes. That is, a pro forma HHI analysis illustrates how a proposed transaction—merger or acquisition, for example will change a market's concentration.
The bank merger guidelines also describe under which pro forma situations the DOJ generally will not challenge a transaction. For the banking industry, this is known as the "1,800/200 rule." That is, the department generally will not challenge a transaction unless the pro forma HHI is greater than 1,800 AND the change in HHI resulting from the transaction is greater than 200 points.