Prevailing wisdom tells us that markets are becoming increasingly more concentrated. One only needs to turn on the nightly news and hear about the latest acquisition by Google, Apple, or Microsoft to believe that market competition is declining. Yet, if we delve a little deeper, we discover that measurements for market concentration can vary wildly depending on how they are performed.
The reason concentration is important to antitrust regulators is its use as a proxy for competition. Though ACI has questioned the validity of this argument, the Federal Trade Commission still uses concentration to inform its decision-making on merger reviews. Thus, it is incumbent on the public to understand how concentration is measured and the potential folly with different metrics.
The measurement used by the FTC to determine a market’s level of concentration is the Herfindahl-Hirschman Index (HHI). The HHI is a fairly simple measurement. It takes the percentages of each market held by individual firms, squares it, and then adds them together (e.g. 10%^2 + 30%^2 +16%^2…). The result is a number between 1 and 10,000, with a higher number representing a more concentrated market.
Yet, a problem with the HHI is that “markets” are not objective metrics. Therefore, how one defines markets will determine the HHI. A recent National Bureau of Economic Research (NBER) study provides a good example. The study found that when plotting changes in HHI over the last 30 years, one will get opposite results depending on whether the market was defined by-products or sectors of the economy. For example, the aluminum container sector has become increasingly concentrated over time, but the soda and spray paint product markets (which are both partially included in the previous “sector”) have become less concentrated.
The NBER argues that a product approach makes more sense from a consumer perspective since consumers do not find items within the same “sector” interchangeable. Thus, these items represent different markets, while interchangeable products exist within individual markets. In other words, a measurement of market concentration from a consumer’s point of view would focus on interchangeability and indicate a decrease in HHI over the last few decades.
A study by the Federal Reserve Bank of Richmond found that since the 1990s, market concentration nationally has been increasing. According to the Richmond Fed, this is corroborated by other studies that have been conducted on the subject, implying a consensus around the finding that concentration in markets has increased nationally over the past 30-40 years. However, even in this study, an interesting distinction was made regarding local market concentration, which has declined over the same period. Researchers concluded that large firms may have a pro-competitive effect on the local markets they enter.
HHI is a measurement, and like all measurements, it is highly dependent on its inputs, in this case how the “market” is defined. An HHI that measures the interchangeability of a product market is inherently more focused on the perspective of consumers, while one that views the market in terms of sectors is not. Depending on definitions, the HHI will be significantly different, in some cases, the results will be the complete opposite. Anyone who hears claims about market concentration ought to keep this in mind so as to not be fooled into believing a narrative over reality.