Ebrahim AlhamedFrameworks Library

m.05 · II · Power, Strategy & Rents · Competition, Capabilities & Rents

The HHI, Economic Rents & Innovation

Economic rent = profit above the competitive level. All strategy is about building and defending one.

The core idea

In asymmetric markets, firms with lower costs (or better brands, or more users) earn economic rents — profits above the competitive level — and the Herfindahl-Hirschman Index measures how concentrated those rents are. Innovation by a leading firm amplifies the advantage; entry erodes it. Regulators pick a side. — after Myatt, Porter & antitrust tradition

The hero diagram

Sources of defensible rent.

Six common sources. Most durable advantage combines two or more.

Hexagon diagram Six-vertex hexagon centred on Rents with vertices: Scale, Network, Brand, Switching cost, IP, Regulation. Rents profit above competitive Scale Network Brand Switching cost IP Regulation

Mechanisms worth naming

The levers in the machine.

Herfindahl-Hirschman Index · Antitrust theory
HHI = Σ(share%)² · range 10,000/N (equal firms) to 10,000 (pure monopoly)
FTC threshold: HHI > 2,500 = highly concentrated. Share expressed in percent.
Economic Rents · Porter / Myatt
profit above competitive level · source: cost, brand, network, IP
Sustainable rents require barriers to replication.
Strategic Effects of Innovation · Myatt
cost-reducing: winner takes more · quality-improving: demand shifts
Innovation by the leader widens the gap; by the follower, may not break even.
Entry & Industry Dynamics · Classical IO
expected profit vs entry cost · equilibrium N
Firms enter until marginal entrant earns zero economic profit.
Pass-Through · Myatt
% of cost change that reaches price
Low-elasticity demand → high pass-through (consumers pay).

How to apply

Assessing your own market position.

  1. Compute the HHI. Sum the squared market shares. Where are you in the concentration scale?
  2. Name your source of rent. Scale, network, brand, IP, switching cost, regulation. At least one, ideally two.
  3. Model entry. At current profits, how close is the break-even entrant?

Key reading · Quantity Competition and Strategic Effects · Myatt

Capabilities create unequal profits.

The firm with the cost advantage earns disproportionately more in Cournot — market share times margin — and that rent is what pays for the next round of innovation. This is why first-mover capability advantages tend to compound.

Capability → margin → share → capability. The virtuous loop of strategy.

← m.04 The 1/2 Rule & Cournot ··· m.06 Four Structures. One Spectrum. →