Glossary of competition terms

This Glossary was prepared by DG COMP and the OECD for non-competition specialists. Each term is enriched with references of national case laws from the e-Competitions Bulletin. (© European Union - © OECD)

Concentration indexes

Herfindahl-Hirschmann-Index (HHI)

Specific measurement of market concentration, that is of the extent to which a small number of firms account for a large proportion of output. The HHI is used as one possible indicator of market power or competition among firms. It measures market concentration by adding the squares of the market shares of all firms in the industry. Where, for example, in a market five companies each have a market share of 20%, the HHI is 400 + 400 + 400 + 400 + 400 = 2000. The higher the HHI for a specific market, the more output is concentrated within a small number of firms. In general terms, with an HHI below 1000 the market concentration can be characterised as low, between 1000 and 1800 as moderate and above 1800 as high. (...)

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Various concentration indexes or measures have been suggested in the field of industrial organization economics. These measures are used to describe market structure and/or as a prima facie indicator of market power or competition among firms. Essentially, concentration indexes attempt to measure the number and relative size inequality of firms. The most frequently used measures are:

Concentration Ratio: The percentage of total industry output (or other such measure of economic activity, e.g., sales revenue, employment) which a given number of large firms account for. The four-firm concentration ratio (CR4) measures the relative share of total industry output accounted for by the four largest firms. Similarly, CR3, CR5, CR8, etc. measures may be computed. The number of large firms are ranked and grouped in order to avoid disclosure of confidential economic information pertaining to individual firms. A disadvantage of the concentration ratio is that it does not indicate the total number of firms that may be operating and competing in an industry. For example, two industries with the same high CR4 levels of 75 percent may differ nonetheless because one industry may have few firms while the other may have many firms.

Herfindahl-Hirschman Index (HHI): This measure is based on the total number and size distribution of firms in the industry. It is computed as the sum of the squares of the relative size of all firms in the industry. Algebraically it is:

si "is" the relative output (or other measures of economic activity such as sales or capacity)of the "th" firm,and "n" is the total number of firms in the industry. In an industry with one firm (monopoly), the HHI measure will be equal to 1. In a duopoly with two equal sized firms, the HHI measure will be: (0.5) + (0.5) = 0.50

The HHI may be computed on a base of 1 (as in the above examples) or 1 000 or 10 000. The index is used, for example, in the United States Antitrust Division Merger Guidelines as an administrative criterion to screen mergers that may warrant further examination for their effects on competition. The HHI has several mathematical and economic theoretic properties which make it a desirable concentration measure.

There are other measures of concentration, e.g., the Lorenz Curve, Gini Coefficient, Inverse Index and Entropy. These measures, while of different theoretic significance, are not as frequently employed in industrial organization and competition policy analysis as the Concentration Ratio and the Herfindahl- Hirschman Index.