VRIO: From Firm Resources to Competitive Advantage

The VRIO Framework or VRIO Model is part of the Resource-Based View (RBV), which is a perspective that examines the link between a company’s internal characteristics and its performance. RBV is therefore complementary to the Industrial Organization (I/O) perspectives that look more at external factors such as competitiveness in order to determine performance and profit potential (e.g. Porter’s Five Forces). The supporters of RBV argue that organizations should look inside the company to find the sources of competitive advantage instead of looking at the competitive environment. The key concepts within this view are therefore Firm Resources and Sustainable Competitive Advantage. Firm resources can be defined as ‘all assets, capabilities, organizational processes, firm attributes, information and knowledge controlled by a firm that enables it to improve its efficiency and effectiveness’. Resources are often classified into categories such as tangible (e.g. equipment, machinery, land, buildings and cash) and intangible (e.g. trademarks, brand reputation, patents and licenses) or physical, human and organizational resources. In order for companies to transform these resources into sustainable competitive advantage, resources must have four attributes that can be summarized into the VRIO framework.

Valuable (VRIO)

First and foremost resources must be valuable. According to the RBV, resources are seen as valuable when they enable a firm to implement strategies that improve a firm’s efficiency and effectiveness by exploiting opportunities or by mitigating threats. Another way to assess whether a resource or investment is valuable is by looking at its Net Present Value (NPV), meaning that the costs invested in the resource should be lower than the expected future cash flows discounted back in time. If non of the resources possessed by a firm are considered valuable, the focal firm is likely to have a competitive disadvantage.

VRIO Framework Video Tutorial

Rare (VRIO)

Secondly, resources must be rare. Resources that can only be acquired by one or few companies are considered to be rare. If a certain valuable resource is possessed by a large amount of players in the industry, each of the players has a capability to exploit the resource in the same way, thereby implementing a common strategy that gives non of the players a competitive advantage. Such a situation is indicated as competitive parity or competitive equality. In case a company does possess a large amount of resources that are valuable and rare, it is likely to have at least temporary competitive advantage.

Inimitable (VRIO)

Although valuable and rare resources may help companies to engage in strategies that other firms cannot pursue since the other firms lack the relevant resources, it is no guarantee for long-term competitive advantage. It may give the focal company a first-mover advantage but competitors will probably try to imitate these resources. Another criteria that resources should meet is therefore that they should be hard and costly to imitate or substitute. According to the RBV, resources can be imperfectly imitable due to a combination of three reasons:

Unique historical conditions: choices made in the past influence the options a company has in the present and future (path-dependency). Similarly, a company that has located its facilities on what turns out to be a much more valuable location than initially anticipated, has an imperfectly imitable physical resource.
Causal ambiguity: causal ambiguity exists when the link between the resources controlled by the focal company and its sustainable competitive advantage is not fully understood. Competitors won’t be able to duplicate the focal company, since they simply don’t know which resources they should imitate.
Social complexity: if the most important resource of a company is a combination of the strenght of its social network, interpersonal relations, a company’s culture and its reputation among both suppliers and customers, it is very hard for competitors to build an identical social network since it is dependent on so many different factors.

If a company’s resources are both valuable, rare and inimitable due to the reasons mentioned above, the focal company has a high potential to gain a competitive advantage that is sustainable over time. There is however one more important criteria that needs to be present within the company.

Organization-wide supported (VRIO)

The resources themself do not create any advantage for a company if the company is not organized in way to adequately exploit these resources and capture the value from them. The focal company therefore needs the capability to assemble and coordinate resources effectively. Examples of these organizational components include a company’s formal reporting structure, strategic planning and budgeting systems, management control systems and compensation policies. Without the correct organization to acquire, use and monitor the resources involved, even companies with valuable, rare and imperfectly imitable resources will not be able to create a sustainable competitive advantage. When all four resource attributes are present, a company is save to assume it has a distinctive competence that can be used as source of sustainable competitive advantage. Below is a diagrom that sums up the four VRIO attributes and the resulting advantages the company has in different situations.

Note that the VRIO framework is a follow-up of the VRIN framework (Valuable, Rare, Hard to Imitate, Non-substitutable). The creator of the VRIN and VRIO framework, Jay Barney, combined the I and N into one attribute and added the O as extra criteria. Inimitability in the VRIO framework therefore means that resources are hard to imitate because competitors cannot duplicate and/or substitute them. It is recommended to combine this framework with Porter’s Value Chain Analysis in order to create a more complete overview of the strengths and weaknesses of the organization’s internal factors.

VRIO Framework

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.

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.

The V in the framework of Vrio Analysis answers the basic questions that are the resources and capabilities are valuable for the company’s growth and development or not. And will they be able to exploit and make optimal use of the opportunity available for the growth or mitigate the threat posed at the marketplace?

If it defines one of the two aspects mentioned above then it can be considered as the strength of the company and if it does not, it is the sheer weakness of the company that needs to be worked on in a dedicated manner. However, depending on the merit of the situation and the industry domain, some of the resources and capabilities can be considered as a weakness to one company and strength to the other.

Below mentioned are the six common types of opportunities that a firm can exploit for its growth and development are:

Cultural shift amongst the target audience

Technological change

Demographic change

Economic change

International events

Legal and Political conditions

The five threats that the firm’s resources or capabilities could avoid or mitigate are:

The threat of competition or rivalry

Threat of buyers

Threat of suppliers

The threat of new entrants in the market

Threat of substitutes

In both the cases of exploiting the opportunity or mitigating the threat, the end result lies in the increase of the revenues, decrement in the costs or both the scenarios depending on the merit of the situation and the play of internal and external factors affecting the operations of the company.

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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.

The concept of rarity results in the competitive advantage for the firm as the firm has the valuable set of resources and capabilities that are extremely unique and special as compared to the competitors in the market and gives an edge to the firm amidst the dynamic nature of the market. The question arises on how to figure out if the firm’s resources are rare in nature and help it gives a competitive edge in the industry?

The available resources and capabilities of the firm should be able to sustain the competitive advantage being short in supply and should persist over a period of time. If both the factors are not met, the firm fails to attain the objective of competitive advantage 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.

In the framework of Vrio Analysis, the primary and main question on the front of Imitability arises that, do the firms without any set of unique resources and capabilities face the demerit of cost disadvantage for obtaining or developing it as compared to its competitor’s firms that already possess the same. The companies that have the rare and valuable resources that are quite unique in nature and are quite difficult to imitate gain the first mover advantage in the market gaining the competitive advantage.

To gain the competitive edge and attain the objectives of higher sales and elevated profits, the companies optimally harness on its rare and valuable resources to exploit the growth opportunities available or mitigate the threat posed by the external factors such as growing competition, change in the government policies or evolving tastes and preferences of the customers.

When the competitors of the company discover the same, they either ignore and continue with their business operations with the old ways with whatever amount of profits they have been earning or in the second option, they carefully understand and analyze the resources that work as the competitive advantage for the firm and try to duplicate or imitate the same.

However, if the resources are quite innovative and the resources are not that easy to access, imitation gets quite difficult. And in such as case, the company enjoys the long-term and sustained competitive advantage in the market-beating its arch-rivals and competition.

Various forms of Imitation

The imitation can be done in two forms, either through direct duplication or coming up with the substitutes. After the careful observation and analysis of the firm’s resources possessed by the firm that works in its favor as the competitive advantage, the competitive firm directly imitates. If the cost of imitation is high, the company will be able to sustain the competitive advantage on a long-term basis and if not, it will be temporary in nature. The second option for the imitating firm is to come up with the substitute to gain the similar level and form of competitive advantage.

Cost of Imitation of the resources

Special and Unique Historical Conditions through which the innovative firm gains low-cost access to exceptional resources in a particular time and space,

In the case of causal ambiguity, the imitating firm cannot figure out and analyze the factors that lead to the competitive advantage of an innovative firm,

The case of social complexity arises when the resources involved in gaining competitive advantage are based on interpersonal relationship, culture, and other social backgrounds.

When the innovative resources work as the long-term competitive advantage is duly certified through the process of Patents by the specific authorities.

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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.

The next aspect in the framework of Vrio Analysis is the organization that comprises of many factors that include the compensation policies, management reporting structure, and the management control systems for the entire hierarchy of the firm. The management reporting structure comprises of the aspects of the various reporting authorities and who reports to whom in the organization.

The management control system comprises the rules and regulations to make sure that the manager’s decisions are well aligned with the firm’s strategies. It consists of the regular meetings, budgeting procedures, and the other reporting activities to keep the management well informed about the day-to-day activities. The informal activities include the company’s innate culture and motivating employees to monitor each other to attain the firm’s aims and objectives.

To make the employees work in a certain order, the company comes up with the various compensation policies such as bonuses; leave salaries, travel allowances, additional vacation days to keep them motivated that will help the firm to attain the competitive advantage in the market.

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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
Valuable?	Rare?	Costly to Imitate?	Is a company organized to exploit it?
Excellent employee management
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.

There are many more businesses that have VRIO resources or capabilities, including many of the companies we analyzed using swot analysis.