Thursday, June 14, 2012

Aggregation and the Herfindahl index

The Herfindahl Index (AKA the Hirschman-Herfindahl Index or HHI) is a measurement of the competitiveness of a particular industry. The index gives a figure between 0 and 1, with those markets closest to zero being more competitive and those closest to 1 being an (almost) monopoly.

An increase in the index typically means that there’s been a decrease in competition and therefore greater market power to those still operating. Whereas a decrease towards zero indicates more companies fighting over the same customer base and therefore the existence of a more ‘perfect’ and competitive market.
So why is the Herfindahl Index important in the online aggregators markets? Well, over the last decade, the appearance of aggregators in different online markets has created a more level playing field for customers; by collating the rates and fees for different suppliers and presenting them to the online user in an easy-to-compare format. Therefore in those markets where price is so-often the defining decision factor, such as utilities, financial services and travel, the use of aggregators increases competition and pushes the Herfindahl Index figure closer to zero.

Take the UK motor insurance market right now. As you will see from the diagram below (sourced from Towers Watson’s report ‘why aren’t we making money’

In the last 10 years (really since the appearance of which was the first UK motor insurance aggregator) the HHI has moved closer to zero.

So what are the implications of this? Well, if anything is predictable, it is that the UK motor insurance market is going to get more (not less) price sensitive over the next few years, becoming more like the oil and airline industry in its competitiveness, unless something happens to interrupt this trend……

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