Is your market competitive, or concentrated? What’s the difference, and how can you be objective about it and not just subjective? The United States government uses a measure called HHI – the Herfindal-Hirschman Index – as an objective measure of how competitive a market is. They use this measure to determine if a company is operating monopolistically, or to determine if a merger needs to be explored from an anti-trust perspective. The ask the question: would the merger create an anti-competitive market?
You can use this metric to get insight into how competitive your market is, and to gain a better appreciation for trends in your market. Read on to review the competitive landscapes and trends for email, search engines, browsers, and internet service providers.
Email Client Competition
It is hard to compete in the market for email clients (the applications people use to read their email). Usually people will describe this market as “very competitive” – meaning that there are some products that dominate the market. What people really mean is that it is “very hard to compete” in the email client market. Take a look at this market data from fingerprint.
The graph shows the percentage of emails that are read in each email client by consumers (blue, on the left) and business users (red, on the right). Yahoo! Mail, Outlook, and Hotmail clearly dominate this space. Almost three million emails were analyzed to produce this market-share data. The emails were opened by people, and fingerprint determined which email clients people used to read the emails. It would definitely be hard to compete in this market with the introduction of a new email client – but is this market competitive?
Definition of Competitive and HHI
The United States government classifies markets based on degrees of competitiveness – competitive, moderately concentrated, and concentrated. They use an objective measurement, the HHI (Herfindal – Hirschman Index, sometimes called the Herfindal Index), to determine the proper classification of each market.
To calculate the HHI for a market, you take the market share captured by each company and square it. Then you add up those values to determine an HHI value.
A pure monopoly market is one where a single company has 100% market share. The HHI calculation for that market would be 100*100 = 10,000. That is the highest possible HHI value, reflecting the complete absence of competition.
A market with 100 competitors, each holding 1% of the market would have an HHI = the sum of 1*1 for each of the 100 competitors = 100. That is an incredibly low HHI value, reflecting an almost purely competitive market. [At this point, you are probably wondering, "How do I find out the market share of the 99th largest company?" - don't worry, you won't need to. We'll cover that later.]
The US government has declared that markets be classified based on the following ranges of HHI values:
- HHI below 1000 – a competitive market. There are no dominant competitors in this market.
- HHI between 1000 and 1800 – a moderately concentrated market
- HHI above 1800 – a concentrated market. There are one or more dominant competitors in this market. Higher HHI values translate into fewer, more dominant competitors.
Anecdotally, the HHI values for the consumer and business email client data (shown in the graph above) are 2254 and 2650, respectively. While Yahoo! Mail, Outlook, and Hotmail collectively dominate both markets, Outlook and Hotmail dominate even more (relative to Yahoo! Mail) in the business email client market. The HHI shows this distinction with a 400 point (20%) difference between the two markets.
The US government uses this data to establish context – is a company operating in a concentrated market – one that promotes collusion, or is the company operating in a competitive (as in “free market”) market? The government also uses HHI values as a litmus test for determining if a proposed merger might be anti-competitive. If combining the market share of two companies results in an increase in the HHI calculation for a market of more than 100 points, then the move will raise anti-trust concernts. I am not an anti-trust lawyer, but my interpretation is that if a merger does not raise the HHI value by more than 100 points, that would be evidence that could be used to argue that the merger is not anti-competitive.
You can get useful insights about a particular market from the HHI value, that may guide your strategy for growing your market share, and apply them as part of your prioritization strategy. Since it is an index that ranges from 0 (for an infinite number of competitors with effective zero market share) to 10,000 (for a pure monopoly), a difference of a few points between two HHI values does not yield a lot of insight. A difference of hundreds or thousands of points does yield insight.
Avoiding Analysis Paralysis
One challenge you face is knowing when to stop gathering market share data, in order to calculate the HHI for a market. I gathered a couple hundred data points in a dozen different market analyses, and determined that there is a reasonable stopping point, where additional leg work does not yield additional insight. I’ve combined those findings in the following chart:
As you record market share data, each new competitor adds to the total market share already analyzed. That value is captured on the vertical axis of the chart above. The horizontal axis shows how much the HHI value for any particular market will increase by gathering one more data point. When adding the data for one more competitor has little or no impact on the resulting HHI calculation, you can stop gathering data.
There are two distinct curves present above – the lower one represents a competitive market (HHI = 223), and the upper one represents multiple concentrated markets (HHI values ranging from 2254 to 6753).
By the time you’ve addressed more than 50% of the market share, additional analysis increases the calculated HHI value by less than 0.1% (per additional competitor). In one market I analysed, the top 20 competitors combined had just under 50% market share. Including the next 50 competitors in the analysis increased the HHI by 2% (from 219 to 223). You can’t gain any insight from that difference in value. A good rule of thumb is to only look at the top 10 competitors, or however many it takes to capture 50% market share.
In a concentrated market, once 90% of the market share has been calculated, the incremental increase to the HHI value by adding additional competitors is also negligible.
Looking at Trends
One powerful way to apply HHI measures for a market is to look at the trends of the market – is it growing less competitive or more competitive? Specifically, are dominant competitors gaining market share, or losing market share? Having this insight can tell you who’s products are succeeding, so you can focus your analysis effort. The following diagram shows how competitiveness has been trending for the last five years in the web browser and search engine markets.
The lines represent the HHI values (downward sloping blue line is for web browsers, upward sloping red line is for search engines) that indicate the competitiveness (or concentration) of the two markets over the years 2005 – 2009. The inset on the left shows market share data for web browsers from 2005-2009. The inset on the right shows market share data for search engines from 2005-2009.
The HHI values for both markets indicate that they are both very concentrated – with a small number of companies controlling each market. From reviewing the HHI values, you can see that the web browser market is gradually becoming more competitive and the search engine market is becoming less competitive. Both markets are dominated by a handful of companies.
A Competitive Market – Internet Service Providers
The internet service provider (ISP) market, unlike the others we’ve looked at, is very competitive. The HHI value for the ISP market is 223. A pie chart of the major competitors shows that there is no clear dominance by any one provider.
As a column chart (to be consistent with the other charts here), the same ISP Mar 2009 market share data looks like the following:
There is not a set of clearly dominating ISPs – this is a competitive market – based on just looking at share data.
However, there’s a big danger in just looking at the numbers. Internet service providers, while competitive in aggregate, generally have dominant market share for any one physical region of the country. Rogers does not offer internet services in Texas, and Comcast does not offer them in my neighborhood. So, from an end-customer’s perspective, this competitive data is almost meaningless. It still serves as an example of a very competitive market, in contrast with the email client, web browser, and search engine markets we also reviewed.
Understanding the problems that plague the customers in your market is critical to being a successful product manager. Understanding your competition (and their solutions to the problems) in your market is also very important. The HHI value provides a metric for measuring competitiveness in particular markets. Your approach to competing in a particular market will be different, depending on the nature of the competition in (and competitiveness of) your market.
Note that this is a primarily red ocean analysis – a blue ocean analysis is a focus on finding ways to redefine your market so that competition is irrelevant. You can read about the differences in Blue Ocean Strategy, which is this month’s Smarter Product Managers book club book, created by Cindy Alvarez on the Booksprouts site (you may need to create a free account to view the page). Analysis of the existing market is still required in order to define a new market – you just apply your insights in different ways.