VRIO Framework

| October 21, 2013

A question asking: 'What makes you unique?'.
A question summarizing VRIO resource.

Definition

VRIO framework
is the tool used to analyze firm’s internal resources and capabilities to find out if they can be a source of sustained competitive advantage.

Understanding the tool

In order to understand the sources of competitive advantage firms are using many tools to analyze their external (Porter’s 5 Forces, PEST analysis) and internal (Value Chain analysis, BCG Matrix) environments. One of such tools that analyze firm’s internal resources is VRIO analysis. The tool was originally developed by Barney, J. B. (1991) in his work ‘Firm Resources and Sustained Competitive Advantage’, where the author identified four attributes that firm’s resources must possess in order to become a source of sustained competitive advantage. According to him, the resources must be valuable, rare, imperfectly imitable and non-substitutable. His original framework was called VRIN. In 1995, in his later work ‘Looking Inside for Competitive Advantage’ Barney has introduced VRIO framework, which was the improvement of VRIN model. VRIO analysis stands for four questions that ask if a resource is: valuable? rare? costly to imitate? And is a firm organized to capture the value of the resources? A resource or capability that meets all four requirements can bring sustained competitive advantage for the company.

VRIO Framework is illustrated, which tests if a resource or capability is valuable, rare, costly to imitate and if a company is organized to catpure value from it. If an answer is yes to all of the questions than the resource can bring sustained competitive advantage.

Adopted from Rothaermel’s (2013) ‘Strategic Management’, p.91

Valuable
The first question of the framework asks if a resource adds value by enabling a firm to exploit opportunities or defend against threats. If the answer is yes, then a resource is considered valuable. Resources are also valuable if they help organizations to increase the perceived customer value. This is done by increasing differentiation or/and decreasing the price of the product. The resources that cannot meet this condition, lead to competitive disadvantage. It is important to continually review the value of the resources because constantly changing internal or external conditions can make them less valuable or useless at all.

Rare
Resources that can only be acquired by one or very few companies are considered rare. Rare and valuable resources grant temporary competitive advantage. On the other hand, the situation when more than few companies have the same resource or uses the capability in the similar way, leads to competitive parity. This is because firms can use identical resources to implement the same strategies and no organization can achieve superior performance.

Even though competitive parity is not the desired position, a firm should not neglect the resources that are valuable but common. Losing valuable resources and capabilities would hurt an organization because they are essential for staying in the market.

Costly to Imitate
A resource is costly to imitate if other organizations that doesn’t have it can’t imitate, buy or substitute it at a reasonable price. Imitation can occur in two ways: by directly imitating (duplicating) the resource or providing the comparable product/service (substituting).

A firm that has valuable, rare and costly to imitate resources can (but not necessarily will) achieve sustained competitive advantage. Barney has identified three reasons why resources can be hard to imitate:

  • Historical conditions. Resources that were developed due to historical events or over a long period usually are costly to imitate.
  • Causal ambiguity. Companies can’t identify the particular resources that are the cause of competitive advantage.
  • Social Complexity. The resources and capabilities that are based on company’s culture or interpersonal relationships.

Organized to Capture Value
The resources itself do not confer any advantage for a company if it’s not organized to capture the value from them. A firm must organize its management systems, processes, policies, organizational structure and culture to be able to fully realize the potential of its valuable, rare and costly to imitate resources and capabilities. Only then the companies can achieve sustained competitive advantage.

Using the tool

Step 1. Identify valuable, rare and costly to imitate resources

There are two types of resources: tangible and intangible. Tangible assets are physical things like land, buildings and machinery. Companies can easily by them in the market so tangible assets are rarely the source of competitive advantage. On the other hand, intangible assets, such as brand reputation, trademarks, intellectual property, unique training system or unique way of performing tasks, can’t be acquired so easily and offer the benefits of sustained competitive advantage. Therefore, to find valuable, rare and costly to imitate resources, you should first look at company’s intangible assets.

Finding valuable resources:

An easy way to identify such resources is to look at the value chain and SWOT analyses. Value chain analysis identifies the most valuable activities, which are the source of cost or differentiation advantage. By looking into the analysis, you can easily find the valuable resources or capabilities. In addition, SWOT analysis recognizes the strengths of the company that are used to exploit opportunities or defend against threats (which is exactly what a valuable resource does). If you still struggle finding valuable resources, you can identify them by asking the following questions:

  • Which activities lower the cost of production without decreasing perceived customer value?
  • Which activities increase product or service differentiation and perceived customer value?
  • Have your company won an award or been recognized as the best in something? (most innovative, best employer, highest customer retention or best exporter)
  • Do you have an access to scarce raw materials or hard to get in distribution channels?
  • Do you have special relationship with your suppliers? Such as tightly integrated order and distribution system powered by unique software?
  • Do you have employees with unique skills and capabilities?
  • Do you have brand reputation for quality, innovation, customer service?
  • Do you do perform any tasks better than your competitors do? (Benchmarking is useful here)
  • Does your company hold any other strengths compared to rivals?

Finding rare resources:

  • How many other companies own a resource or can perform capability in the same way in your industry?
  • Can a resource be easily bought in the market by rivals?
  • Can competitors obtain the resource or capability in the near future?

Finding costly to imitate resources:

  • Do other companies can easily duplicate a resource?
  • Can competitors easily develop a substitute resource?
  • Do patents protect it?
  • Is a resource or capability socially complex?
  • Is it hard to identify the particular processes, tasks, or other factors that form the resource?

Step 2. Find out if your company is organized to exploit these resources

Following questions might be helpful:

  • Does your company has an effective strategic management process in organization?
  • Are there effective motivation and reward systems in place?
  • Does your company’s culture reward innovative ideas?
  • Is an organizational structure designed to use a resource?
  • Are there excellent management and control systems?

Step 3. Protect the resources

When you identified a resource or capability that has all 4 VRIO attributes, you should protect it using all possible means. After all, it is the source of your sustained competitive advantage. The first thing you should do is to make the top management aware of such resource and suggest how it can be used to lower the costs or to differentiate the products and services. Then you should think of ideas how to make it more costly to imitate. If other companies won’t be able to imitate a resource at reasonable prices, it will stay rare for much longer.

Step 4. Constantly review VRIO resources and capabilities

The value of the resources changes over time and they must be reviewed constantly to find out if they are as valuable as they once were. Competitors are also keen to achieve the same competitive advantages so they’ll be keen to replicate the resources, which means that they will no longer be rare. Often, new VRIO resources or capabilities are developed inside an organization and by identifying them you can protect you sources of competitive advantage more easily.

VRIO example

Google’s capability evaluated using VRIO framework

Google's VRIO capability
Excellent employee management
Valuable? Rare? Costly to Imitate? Is a company organized to exploit it?
Yes Yes Yes Yes
Result: sustained competitive advantage

Google’s ability to manage their people effectively is a source of both differentiation and cost advantages. Unlike other companies, which rely on trust and relationship in people management, Google uses data about its employees to manage them. This capability allows making correct (data based) decisions about which people to hire and the best way to use their skills. As a result, Google is able to hire innovative employees that are also very productive ($1 million in revenue per employee). Besides being valuable, it is also a rare capability because no other company uses data based employee management so extensively. Is it costly to imitate? It is costly to imitate, at least, in the near future. First, companies should build the highly sophisticated software, which is both costly and hard to do. Second, HR managers should be trained to make data based decisions and forget their old management methods. Is Google organized to capture value from this capability? Certainly, it has trained HR managers that know how to use the data and manage people accordingly. It also has the needed IT skills to collect and manage the data about its employees.