What is VRIO Analysis?
Resources and capabilities are drivers of competitive advantage for businesses. The business industry has grown highly competitive in the 21st century driven by technological advancement as well as increased economic activity, the rise of the middle class, and the growing buying power of the customers worldwide. While all these factors have kept intensifying the level of competition in the industry, the importance of competitive moat is highlighted in terms of market expansion and profitable business growth. A sustainable competitive advantage comes from core competencies and core competencies are developed from resources and capabilities. However, not all resources and capabilities give rise to core competencies. Resources and capabilities do not give birth to core competencies alone but have to be bundled together in unique ways to derive advantage from. This is true about nearly every firm that has acquired a leading position in its industry from Apple to Amazon and Starbucks to Nike.
Nearly everything that a company owns can be classified as a resource or capability. To understand why performance differs from one firm to another, it is important to narrow down on the resources and capabilities that give rise to core competencies. This can be done through the VRIO framework. VRIO is an acronym that stands for Valuable, rare, inimitable, and Organized. A resource or capability should be valuable, rare ( and non-substitutable), inimitable as well as organized to generate a sustainable source of competitive advantage.
The VRIO framework is also the foundation for internal analysis. One most common answer you get when you ask a manager why his firm does better compared to another or why another firm is performing poorly compared to his is because of his people. However, this fails to answer the question fully. It is because you need to probe deeper and find out what is especially so good about his people that makes the difference. So, is it just the people or is there something special about the organization that brings the best out from inside the people.
Do not the competitors have similar people working for them? Or cannot they steal your best talent? If it was just something inside the people then the competitors too could hire talented personnel to get ahead. However, it turns out that there is some difference between your organization, its culture, work environment, and other factors that marks the difference in the performance of one firm’s human capital and another. These are important questions and form the basis of the VRIO analysis and help you find out why some resources help a company perform better than the others.
The competitive position of a firm can also be explained by answering the question if the firm has VRIO resources.
Understanding the VRIO framework:
As already explained, VRIO is an acronym that stands for Valuable, Rare, Inimitable, and Organized. These four bricks represent the four properties of resources and capabilities that allow them to generate a sustainable source of competitive advantage. A competitive advantage can be temporary or sustainable. If a resource or capability satisfies all the four requirements, it will give rise to a sustainable source of competitive advantage. If it satisfies fewer requirements, the result can be a temporary competitive advantage or competitive parity. Now, read about the four properties in detail in the sections below:
A resource or capability is valuable if it allows the firm to exploit the opportunities in the environment or overcome the threats. The extensive distribution network of Amazon is a valuable resource that allows the company to ship millions of products to millions of customers on a daily basis. The resource is valuable because it allows the company to distribute products cost-effectively worldwide. There are millions of sellers worldwide that include small and large businesses that sell their products to a large base of millions of customers through Amazon. These firms have hailed Amazon’s distribution network as the world’s best. Amazon’s fulfillment centers worldwide are a critical part of its distribution network. Across the world, Amazon has established more than 175 fulfillment centers. In North America alone, which is the leading market for Amazon products, the company has established 110 fulfillment centers. After the United States, India has the largest number of Amazon distribution centers. The distribution network of Amazon provides it extensive global reach which is utilized by millions of sellers and hailed as the world’s best.
By having an effective and the world’s largest distribution network which also includes the largest logistics space, Amazon controls the largest share of international online commerce. In this way, Amazon’s distribution capabilities allow it to control a significant part of the world’s e-commerce and therefore hold significant value for the firm. It allows the company to connect millions of sellers worldwide in various regions with prospective customers and thus enhance the competitive value of its online marketplace. If the resource did not allow Amazon to enhance its competitive position or negate the threats in its external environment, it would not have been valuable. However, the way Amazon’s market cap has continued to climb even during the pandemic shows the competitive strength of the firm as well as the significance of its distribution capabilities.
Rare simply means that the particular resource or capability is not widely possessed by other companies. If other companies also have resources and capabilities that are similar in scale and size then the given resource or capability is not rare. For example, let’s take the case of Coca Cola and Pepsi. Both are well-recognized brands and the two largest ones in the soda industry. For Coca Cola, its brand name is a valuable resource but Pepsi’s brand name is also a valuable resource. It is why the brand name of Coca Cola is not a rare resource.
If a firm possesses a valuable resource that is not rare, then it is not having an advantage against its competitors. Such a resource that is valuable but also available to the firm’s competitors allows the firm to be on par with the rival firms not ahead of them. However, the firms that possess resources that are valuable and also rare have a strong edge against the competitors in their respective industries. Such firms can better exploit opportunities or overcome threats compared to other firms that do not have similar resources or capabilities. It will also help the company exploit the opportunities as well as overcome threats in manners not possible for the other companies. Amazon’s control of the world’s largest international distribution network gives it some extra edge in both the United States and internationally over its competitors.
Another important question is how rare a resource really needs to be in order to be a source of competitive advantage for the company. If only one firm has the resource, then the company will have a significant advantage over competitors. However, if a few firms have a rare resource then the companies in question will have an advantage over the other players in the industry. Let’s say two leading firms in the US have similar capabilities. For example, Google and Microsoft. The other technology firms do not have these resources. In that case, these two firms will continue to have a significant advantage over the other players until the other players have also developed the resource or capability. In this way, for a resource or capability to be rare, it must not be widely available to several firms. It is rare only if a few firms possess the resource or capability. It also indicates that the more exclusive a firm’s access to a particularly valuable resource, the greater will be the benefit for the firm of having it.
An imitable resource is a resource that is difficult to imitate or cannot be readily substituted with any other resource. A resource is inimitable or non-substitutable if other firms find it difficult to imitate it or create its substitute. A valuable and rare resource will offer a sustainable competitive advantage only as long as other firms have not acquired it or developed a close substitute for the resource.
In most cases where a market leader has a significant advantage over its competitors in the market due to the competitive advantage gained from a valuable and rare resource, the rivals will most likely try to gain possession of the resource or try to develop a close substitute. So, imitability means acquiring a lacking resource or substituting a similar resource that will offer similar and equivalent benefits. The firms having a valuable and rare resource should try to find out if the competitors face a cost disadvantage in developing the resource or its substitute. There are several ways that competitors can acquire a lacking resource or capability. Firms should also see how time-consuming it will be for a competing company to acquire a lacking resource or find a close substitute.
Every tech leader has a large number of patents to its name. These patents also make technological resources valuable and rare. Not all companies can own them and therefore only .you can sell the products, services and technologies you have patented. It makes that particular resource or capability valuable and rare. It is also why companies in the tech sector invest heavily in research and development to maintain their competitive edge and grow capabilities that are not owned by the other firms in the industry.
The fourth criterion of VRIO is organization. A resource or capability must not just be valuable and rare or inimitable. It must also be organized for exploitation. The mere possession and control of a valuable, rare, and inimitable resource does not generate a competitive advantage. In order to gain a competitive advantage from a valuable, rare, and inimitable resource, the company must also have the organizational capability to exploit the resource. Despite being the last criterion in the VRIO analysis - 'organization', a is compulsory criterion. It is important that the valuable, rare, and inimitable resource a firm possesses is put to use. If the firm possessing the resource cannot use it in the best manner to generate superior results, then the resource or capability will not generate a competitive advantage. There are several such examples where companies gained a significant advantage through innovation but failed to exploit it because they were organized in a manner that they could not gain any benefit from that resource or capability. For example, Xerox developed several innovative resources but failed badly at exploiting time to generate profits. These resources were used by other companies that were better organized.