harvard professor michael e. porter argued that, “theories or models that require restrictive...

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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

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Page 1: Harvard Professor Michael E. Porter argued that, “Theories or models that require restrictive assumptions are untenable…Standard economic models of firms

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.

Page 2: Harvard Professor Michael E. Porter argued that, “Theories or models that require restrictive assumptions are untenable…Standard economic models of firms

Examples of

Modeling with AHP

Page 3: Harvard Professor Michael E. Porter argued that, “Theories or models that require restrictive assumptions are untenable…Standard economic models of firms

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

Page 4: Harvard Professor Michael E. Porter argued that, “Theories or models that require restrictive assumptions are untenable…Standard economic models of firms

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.

Page 5: Harvard Professor Michael E. Porter argued that, “Theories or models that require restrictive assumptions are untenable…Standard economic models of firms

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.

Page 6: Harvard Professor Michael E. Porter argued that, “Theories or models that require restrictive assumptions are untenable…Standard economic models of firms

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.

Page 7: Harvard Professor Michael E. Porter argued that, “Theories or models that require restrictive assumptions are untenable…Standard economic models of firms

AHP Model 1: Predicting the Future of the U.S. Automotive Industry

W eaker

S ta tus Q uo

S tronger

Inc rease /M a inta inP ro f its

W eaker

S ta tus Q uo

S tronger

Indus tryE xpans ion

W eaker

S ta tus Q uo

S tronger

D ive rs if ica t iono f R isk

W eaker

S ta tus Q uo

S tronger

C ont inua t ion o fC om pany

M anagem ent

W eaker

S ta tus Q uo

S tronger

P rospe rty

W eaker

S ta tus Q uo

S tronger

E m p loym ent

W eaker

S ta tus Q uo

S tronger

T echno logy

W eaker

S ta tus Q uo

S tronger

T ransporta t ionIm provem ent

G ove rnm ent

W eaker

S ta tus Q uo

S tronger

E m p loym ent

W eaker

S ta tus Q uo

S tronger

C ont inua t ion o fC om pany

W eaker

S ta tus Q uo

S tronger

B ene f its

Union

W eaker

S ta tus Q uo

S tronger

M arke t S hare

W eaker

S ta tus Q uo

S tronger

P ro f its

W eaker

S ta tus Q uo

S tronger

C ont inua t ion o fC om pany

F ore ign C om pe t ito rs

W eaker

S ta tus Q uo

S tronger

C os t

W eaker

S ta tus Q uo

S tronger

V a lue

W eaker

S ta tus Q uo

S tronger

S ta tus

C onsum ers

A u to Industry F u tu re

Source: The Hierarchon; A Dictionary of Hierarchies, Saaty and Forman, 1996 (Revised Edition)

Page 8: Harvard Professor Michael E. Porter argued that, “Theories or models that require restrictive assumptions are untenable…Standard economic models of firms

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?

Page 9: Harvard Professor Michael E. Porter argued that, “Theories or models that require restrictive assumptions are untenable…Standard economic models of firms

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.

Page 10: Harvard Professor Michael E. Porter argued that, “Theories or models that require restrictive assumptions are untenable…Standard economic models of firms

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?

Page 11: Harvard Professor Michael E. Porter argued that, “Theories or models that require restrictive assumptions are untenable…Standard economic models of firms

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?

Page 12: Harvard Professor Michael E. Porter argued that, “Theories or models that require restrictive assumptions are untenable…Standard economic models of firms

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.

Page 13: Harvard Professor Michael E. Porter argued that, “Theories or models that require restrictive assumptions are untenable…Standard economic models of firms

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

3-5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

S trong

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

"C oopera t ive"

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

W eak

C om pe tit iveP ressu res

(F rom Incen t ives , Do l la r , etc .)

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

N e wD em and

3-5% H ike

2 -3% H ike

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0 -1% Ro llback

R ep lacem entD em and

D om esticM arket

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

E xports

D em andC ond it ions

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

O n P lan

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

S hortages

P roduc t ion

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

Too M uch

3-5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

O n P lan

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2 -3% H ike

1 -2% H ike

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0 -1% Ro llback

Too L it t le

C hange inInvento r ies

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

Fore ign G row thS trong

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

Fore ign G rw othM odera te

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

Fore ign G row thW eak

Im ports

S upp lyC ond it ions

S trong E conom yP a th

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

S trong

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

"C oopera t ive"

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

W eak

C om pe tit iveP ressu res

(F rom Incen t ives , Do l la r , etc .)

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

N e wD em and

3-5% H ike

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0 -1% H ike

0 -1% Ro llback

R ep lacem entD em and

D om esticM arket

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

E xports

D em andC ond it ions

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

O n P lan

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

S hortages

P roduc t ion

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

Too M uch

3-5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

O n P lan

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

Too L it t le

C hange inInvento r ies

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

Fore ign G row thS trong

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

Fore ign G rw othM odera te

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

Fore ign G row thW eak

Im ports

S upp lyC ond it ions

S low G row tho r R ecess ion

A v e ra g e P ric e o f a V e h ic le(G o a l: To D e te rm in e th e M ag n itu de o f th e A n n ou n ce d P ric e C h a n g e )

Page 14: Harvard Professor Michael E. Porter argued that, “Theories or models that require restrictive assumptions are untenable…Standard economic models of firms

AHP Model 2: Level 1 & 2 CriteriaObjective: Forecast Price Change over One-Year

C om petit iveP ressures

(F rom Incen tives , Do lla r , etc .)

D em andC ond it ions

S upp lyC ond it ions

S trong E conom yP ath

C om pe tit iveP ressures

(F rom Incen tives , Do lla r , etc .)

D em andC ond it ions

S upp lyC ond it ions

S low G row thor R ecess ion

A ve ra g e P rice o f a V e h ic le(G o a l: To D e te rm in e th e M ag n itu de o f th e A n n ou n ce d P rice C h a n g e)

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 ------>

Page 15: Harvard Professor Michael E. Porter argued that, “Theories or models that require restrictive assumptions are untenable…Standard economic models of firms

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…

Page 16: Harvard Professor Michael E. Porter argued that, “Theories or models that require restrictive assumptions are untenable…Standard economic models of firms

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.

Page 17: Harvard Professor Michael E. Porter argued that, “Theories or models that require restrictive assumptions are untenable…Standard economic models of firms

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.

Page 18: Harvard Professor Michael E. Porter argued that, “Theories or models that require restrictive assumptions are untenable…Standard economic models of firms

Saaty’s Calculated Random Index Measures for Various

Sizes of “N”

Average Random Consistency Index (R.I.)n 1 2 3 4 5 6 7 8 9 10

R.I. 0 0 .52 .89 1.11 1.25 1.35 1.40 1.45 1.49

--------------------------------------------------

Page 19: Harvard Professor Michael E. Porter argued that, “Theories or models that require restrictive assumptions are untenable…Standard economic models of firms

AHP Model 2: Level 1 CriteriaObjective: Forecast Price Change over One-Year

3-5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

S trong

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

"C oopera t ive"

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

W eak

C om pe tit iveP ressu res

(F rom Incen t ives , Do l la r , etc .)

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

N e wD em and

3-5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

R ep lacem entD em and

D om esticM arket

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

E xports

D em andC ond it ions

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

O n P lan

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

S hortages

P roduc t ion

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

Too M uch

3-5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

O n P lan

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

Too L it t le

C hange inInvento r ies

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

Fore ign G row thS trong

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

Fore ign G rw othM odera te

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

Fore ign G row thW eak

Im ports

S upp lyC ond it ions

S trong E conom yP a th

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

S trong

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

"C oopera t ive"

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

W eak

C om pe tit iveP ressu res

(F rom Incen t ives , Do l la r , etc .)

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

N e wD em and

3-5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

R ep lacem entD em and

D om esticM arket

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

E xports

D em andC ond it ions

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

O n P lan

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

S hortages

P roduc t ion

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

Too M uch

3-5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

O n P lan

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

Too L it t le

C hange inInvento r ies

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

Fore ign G row thS trong

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

Fore ign G rw othM odera te

3 -5% H ike

2 -3% H ike

1 -2% H ike

0 -1% H ike

0 -1% Ro llback

Fore ign G row thW eak

Im ports

S upp lyC ond it ions

S low G row tho r R ecess ion

A v e ra g e P ric e o f a V e h ic le(G o a l: To D e te rm in e th e M ag n itu de o f th e A n n ou n ce d P ric e C h a n g e )

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?

Page 20: Harvard Professor Michael E. Porter argued that, “Theories or models that require restrictive assumptions are untenable…Standard economic models of firms

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.