Herfindahl’s index of industry complexity, and two possible applications to law departments

An article in the Acad. Mgt. Rev., Aug. 2005 at 662, explains that “industry complexity refers to the competition in an industry that stems from concentration, or the market share dominance of one or more firms.” The industry becomes more complex in part because the dominant large firms restrict smaller players’ strategic choices.

One measure of industry complexity is Herfindahl’s index of homogeneity, “the sum of the squared market shares of the publicly traded firms in a sector (four-digit SIC).” If the dominant company has a 40 percent market share, the next has 20 percent and so on, the sum of all those percentages squared would be the index. A high value means there are large players and is associated with high industry complexity (See my post of Oct. 22, 2006: Gini coefficients.).

My hypothesis is that total legal spending as a percentage of revenue declines as the Herfindahl index of a sector rises. Further, someone could calculate a Herfindhl index for law firms in various specialized practice areas. For example, perhaps four firms dominate FCPA defensive counseling, six firms account for 75 percent or more of all Chapter 11 reorganizations, and three firms do more than 80 percent of all US-related legal work in Thailand. If so, high index figures probably go hand in hand with high fees.

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