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HHI Analysis – an Indicator of Monopoly or Fragmented Industry

The Herfindahl index (also known as Herfindahl–Hirschman Index, or HHI) is a measure of the size of firms in relation to the industry and an indicator of the amount of competition among them. It is an economic concept widely applied in competition law, antitrust and also technology management. It is defined as the sum of the squares of the market shares of the 50 largest firms (or summed over all the firms if there are fewer than 50) within the industry, where the market shares are expressed as fractions. The result is proportional to the average market share, weighted by market share. As such, it can range from 0 to 1.0, moving from a huge number of very small firms to a single monopolistic producer. Increases in the Herfindahl index generally indicate a decrease in competition and an increase of market power, whereas decreases indicate the opposite.

The major benefit of the Herfindahl index in relationship to such measures as the concentration ratio is that it gives more weight to larger firms.

H =\sum_{i=1}^N s_i^2

where   is the market share of firm   in the market, and   is the number of firms. Thus, in a market with two firms that each have 50 percent market share, the Herfindahl index equals  .

0.50^2+0.50^2= 1/2

The Herfindahl Index (H ) ranges from 1/N  to one, where N  is the number of firms in the market. Equivalently, if percents are used as whole numbers, as in 75  instead of 0.75, the index can range up to  100^2, or 10,000.

A HHI index below 0.01 (or 100) indicates a highly competitive index.
A HHI index below 0.15 (or 1,500) indicates an unconcentrated index.
A HHI index between 0.15 to 0.25 (or 1,500 to 2,500) indicates moderate concentration.
A HHI index above 0.25 (above 2,500) indicates high concentration

Rank

Airlines Companies

Market share

HHI

1

Delta Airline Inc.

15.2%

231.04

2

United Continental Holding Inc.

14.8%

219.04

3

Southwest Airlines

10.8%

116.64

4

AMR Corporation

9.7%

94.09

5

US Airways Group Inc.

6.7%

44.89

 

Total

57.2%

705.7

 

Market share HHI
Delta Airline Inc.

15.2%

231.04

United Continental Holding Inc.

14.8%

219.04

Southwest Airlines

10.8%

116.64

AMR Corporation

9.7%

94.09

US Airways Group Inc.

6.7%

44.89

Others

42.8%

1831.84

100.0%

2537.54

 

The upper estimate, let us assume that the remaining 48.2% market share in its piece of the market participants. The above mathematical background thread is the idea that these market shares up to the sum of squares 48.2/K. Since the counting of market shares in each of 5 small US Airways Group Inc. ranked at 6.7%, K’s minimum value 42.8/6.7, i.e. is K > 8. For this reason, the 5th place after the maximum sum of squares of market shares 48.2/8=602.5 and HHI, bringing the total up 602.5+705.7=1308.2

The U.S. domestic aviation HHI is between 705.7 and 1308.2 which indicate an uconcentrated index.

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One Response to “HHI Analysis – an Indicator of Monopoly or Fragmented Industry”

  • Dave Dixon says:

    I don’t know where you got your market share data, but the 2013 BTS data (http://www.transtats.bts.gov/) show this:

    Delta 16.3%
    United 15.6%
    Southwest 15.6%
    American 12.7%
    US Airways 8.5%
    JetBlue 5.2%
    Alaska 4.1%
    ExpressJet 2.6%
    SkyWest 2.3%
    AirTran 2.1%
    Others 15.0%

    giving an HHI upper limit HHI of 1271 and a lower limit of 1046. The 2013 HHI calculated from all BTS data is 1058. Using the same data, the AA/US merger will result in a national HHI of 1487.

    But airlines never compete on the national level, they compete by city-pair. Most city pairs are served by no more than four of the top airlines, and many places by three or fewer (per market HHI well above 2500). It is a simple matter to show that city-pairs served by only a few legacy airlines consistently average fares above the national average per passenger-mile, showing that the airlines exercise market power. This kind of competition in known as multimarket contact, and airlines protect their profits by avoiding head-to-head competition aside from an occasional city-pair market. It’s not illegal (unless they collude), and may not be a bad thing (it is a market solution, after all) but it’s wrong to say that the markets in which airlines compete are unconcentrated.