Market shares and concentration levels are helpful in providing indications of the market structure and of the competitive relevance of market players. Antitrust agencies commonly use concentration indexes to measure the concentration level of a relevant market. The Herfindahl-Hirschman Index (“HHI”) is the most common tool. The HHI is equivalent to the sum of the squares of the individual firms’ market shares. The HHI is based on the premise that industry structure correlates with the behavior of its players, which justifies the paradigm of structure-conduct-performance. Other commonly used concentration indexes are the Concentration Ratios (“CRN’”), which refer to the sum of the market shares held by the N largest firms in the relevant market.
According to the OECD (2008), concentration indexes do not consider the relative size of the firms in the relevant market and could thus be less suitable as an initial assessment tool of the potential effects of a merger. However, the HHI proportionately gives greater weight to larger market shares and hence can provide an accurate, initial measure of the degree and/or intensity of competition in a relevant market.
Market concentration and concentration indexes are predominantly calculated based on market shares. However, as recognized in several merger guidelines (§19, EU Merger Guidelines and §5.3 Market Concentration, US Horizontal Merger Guidelines), the impact of a merger in a relevant market should also be evaluated alongside other evidence of the merger’s potential effects on competition, such as the evaluation of recent or potential entry with a small market share that is not representative of its future development; the existence of ‘maverick’ firms or relevant innovators, which may not be reflected in current market shares; the existence of significant cross-shareholdings among market participants (that could be more accurately assessed with the modified HHI developed by O’Brien & Salop, 1999) or the existence of past or ongoing coordination and/or facilitating practices among market players.
The use of HHI is recognized in merger guidelines throughout competition jurisdictions as a first screening tool to identify competition concerns arising from a merger, including in the EU and US. In general, high HHI levels, in combination with high projected variations of HHI levels as a result of a merger or delta, are usually considered to be an initial indicator of competition concerns that likely merit a closer scrutiny of a merger in a relevant market.
The European Commission (“EC”) considers that concerns are unlikely to be raised in markets with a post-merger HHI below 1.000 points. In Sherwin-Williams/Valspar, the EC considered that a low projected variation of the HHI arising out of the merger [100-200 points], regardless of the plausible product market definition, would be indicative of a transaction that would not have significant impact on the market structure. However, that initial finding that a merger is not likely to lessen competition based on post-merger HHI variations does not give rise to an imperative, legal presumption of either the existence or the absence of such concerns.
In the United States, both the DOJ and FTC consider that an HHI below 1.500 points corresponds to unconcentrated markets, an HHI between 1.500 and 2.500 points is indicative of moderately concentrated markets, and highly concentrated markets have an HHI of above 2.500 points (§5.3 Market Concentration, Horizontal Merger Guidelines). The U.S. guidelines consider that small changes in concentration (i.e., post-merger HHI variations of less than 100 points) are unlikely to generate adverse effects in a relevant market and ordinarily do not require further analysis. On the other hand, a rebuttable presumption of likely potential effects is established when mergers taking place in highly concentrated markets (i.e., HHI above 2.500 points) generate a post-merger HHI increase of more than 200 points. While the guidelines presume such mergers to be likely to enhance market power, such presumption may be rebutted by persuasive evidence showing otherwise. In FTC v. Staples, Inc., the Court stated that, although the Merger Guidelines were not binding to them, they do provide “a useful illustration of the application of the HHI”. In using said illustration, it was considered that high levels of pre and post-merger HHIs showed a “reasonable probability” of the anticompetitive effects of the proposed merger.
In the United Kingdom, the CMA also uses certain measures of concentration as an initial screening in order to identify –as the start of a more substantive assessment– whether a merger has the potential to raise competition concerns in the absence of more compelling evidence. For instance, in Masstock Arable (UK) Ltd / Dalgety Arable Ltd, the CMA considered that the low increment of the post-merger HHI suggested that the merger raised no competition concerns. Concentration indexes are considered to be a useful indicator of the merger resulting in a prospect of a substantial lessening of competition. However, for purposes of measuring market concentration, rather than HHI the CMA Merger Assessment Guidelines strongly rely on traditional market shares and the number of effective, post-merger competitors.
Although the HHI has become a common tool in antitrust analysis, it does not work for every setting. The logic behind the HHI derives directly from the Cournot oligopoly model (i.e., when the number of firms decreases, the competitive equilibrium price increases and the HHI increases), which, in turn, is based on quantity competition, suitable for markets where products are homogeneous. When the market is characterized by differentiated products, other technical approaches are more appropriate, since a structural analysis based on concentration indexes could lead to inaccurate predictions, especially when assessing unilateral effects of mergers.