Harvard Professor Michael E. Porter argued that, “Theories or models that require restrictive assumptions are untenable…Standard economic models of firms and product markets have captured little of the complexity and dynamism of actual competition.” Hence, the AHP/ANP model framework is a way around the “standard” approach.

Examples of Modeling with AHP

AHP Model 1: Predicting the Future of the U.S. Automotive Industry Goal: To Predict the Future of the Automotive Industry Actors (Criteria 1): Each factor has there own objectives, which forms a second level criteria. - Management - Government - Unions - Foreign Competition - Consumers

AHP Model 1: Predicting the Future of the U.S. Automotive Industry Objectives (Criteria 2): For Management: (a)_Maintain/Increase Profits, (b)_Industry Expansion in the U.S., (c)_Diversification of Risk, and (d)_Continuation of Automotive Firms. For Government: (a)_Economic Prosperity, (b)_Maintain/Increase the Level of Industry Employment, (c) Technology Development, and (d)_Provide/Improve Methods of Transportation. For Unions: (a)_Desire to Maximize Employment, (b)_Continuation of Auto Firms, and (c)_Improve Employee Benefits.

AHP Model 1: Predicting the Future of the U.S. Automotive Industry Objectives (Criteria 2): For Foreign Competitors : (a)_Penetrate the U.S. Market/Increase Market Share, (b)_Increase their Profit, and (c)_Continuation of the Health of Their Firm. For Consumer: (a)_Cost, (b)_Value, and (c)_Status.

AHP Model 1: Predicting the Future of the U.S. Automotive Industry Alternatives (Likely Scenarios): Weaker - with increasing loss of market share to imports, Status Quo - with steady loss of market share to imports, Stronger - with better products to stem the tide of imports and challenge imports in their home markets.

AHP Model 1: Predicting the Future of the U.S. Automotive Industry Source: The Hierarchon; A Dictionary of Hierarchies, Saaty and Forman, 1996 (Revised Edition)

While this is a framework for understanding and forecasting the industry, it takes an organizational perspective more than an economics perspective. Can We do Better From an Economics Perspective?

Let’s Set Our Forecast Objective and Alternatives. And Then Let’s Assemble the Key Economic Factors About the Industry that We Want to Model.

Let’s be more specific and clearer. Questions to Think About: (1) What do we mean by a domestic automotive industry? (2) What do we mean by domestic sales? (3) What is the forecast horizon? Was that Previous Model Well Specified?

How might we reformuate that forecast objective? The modeling goals could be: (1) Industry Profits (by whom or from where? -- home or abroad?), (2) Domestic Demand, (3) Market Share (of whom? -- Companies that Domestically Produce or Share of Output that is Domestically Owed) What are Possible Objectives from Economic Theory?

How Do We Measure and Model Competition? Competitiveness of an industry must be evaluated in terms of the same industry in other regions, “clusters,” or countries (cross- sectional analysis). The competitiveness of an industry may be inferred from the competitiveness of the main firms in the industry. Australian Government’s Bureau of Industrial Economics (1993) defined competitiveness based on three quantitative indicators: (1) growth rate of sales, (2) the profit/sales ratio, and (3) the profit growth/turnover ratio and six qualitative indicators: (1) product quality and performance, (2) customer satisfaction, (3) product range, (4) profits, (5) costs, and (6) production flexibility. Markusen (1992) defined industry international competitiveness as: “(1) An industry is competitive if it has a level of total factor productivity equal to or higher than that of its foreign competitors. (2) An industry is competitive if it has a level of unit (average) costs equal to or lower than its foreign competitors.

AHP Model 2: An AHP Model of Automotive Demand and Supply to Forecast Price Changes Over a One-Year Horizon

AHP Model 2: Level 1 & 2 Criteria Objective: Forecast Price Change over One-Year Level 1 Question: What is the Likelihood of Slow Growth/Recession in One Year? Level 2 Question: How Strong on the Market Conditions? Economy-wide Criteria >

Form the Matrix of Pairwise Comparison for the Level 1 Criteria Strong Economy Weak/Recession Strong Economy 1 1/N Weak/Recession N 1 Using the 1-9 Saaty Scale, What is the Consensus in the Class on the Likelihood that Weak Growth/Recession is More Likely than Strong Growth? Determine Weights…

How Do You Determine the Respective Weights? Use a consensus forecast for the chance of a recession/slowdown, Use your own judgment/forecast, Base the determination on leading indicators, Or, as we will do here take a survey of class opinion.

Determining if your pairwise comparisons are consistent Calculate the Consistency Index and CI/RI measure. Evaluate the CI/RI ratio as follows if >0.10 (or maybe 0.20) then rethink you assigned comparisons.

Saaty’s Calculated Random Index Measures for Various Sizes of “N” Average Random Consistency Index (R.I.) n R.I

AHP Model 2: Level 1 Criteria Objective: Forecast Price Change over One-Year But even this framework does not capture all of the industry dynamic. How about role of leasing? Should that be explicit? How about the CAFÉ regulations that governed fuel efficiency? Should that be incorporated? What else might be need?

Recap: Why AHP/ANP? AHP is a framework to assemble statistical and judgmental information. The framework models the process in a more flexible mode. It greatest benefit is that it gets you thinking about the industry structure! But, it has drawbacks.