The VRIO Analysis Framework
Introduction to the VRIO Framework
VRIO is an analysis framework for predicting the strategic importance of a given resource to an organization. Although it does not provide a numerical estimation of a resource's worth, it can be quite a powerful tool as part of a larger analysis.
The methodology of the model, often referred to as a resource-based view, is focused upon whether or not an organization can capture significant strategic benefit from a given resource and was first proposed by Professor Jay Barney in 1991.
Note: Resources need not be physical in nature. A corporation could use this model to analyze its holdings of wheat, as it could its logistics capability or patent holdings.
The Resource-Based View
VRIO and other resource-based models suggest that a firm's competitive advantages are a result of its ability to derive value from the resources that it controls. The better a firm can identify and utilize its resources, the better it will compete in the marketplace.
The term VRIO is an acronym for its four constituent areas of analysis:
- V - Is the resource valuable?
- R - Is the resource rare?
- I - Is the resource difficult to imitate?
- O - Is the resource beneficial to the organization?
Starting with the question of value, the user of the VRIO model works his way down the list, analyzing the given resource against the appropriate rubric.
|Valuable?||Rare?||Difficult to Imitate?||Organizationally Compatible?||Result|
|✔||✔||✔||✘||Potential Core Competency|
|✔||✔||✔||✔||Actual Core Competency|
The ideal result is for all four criteria to be satisfied. According to traditional usage instructions, if a resource fails a given test, analysis is halted. As noted in later sections of this document, there may be situations for which the use of this method is not the optimal approach.
Is the Resource Valuable?
The concept of value can be exceedingly complex, but for the sake of discussion we will define value as the potential to achieve a strategic objective.
Many managers consider only two strategic objectives: the reduction of costs, and the augmentation of revenue. However, users of this framework would be advised to consider other potential outcomes including production flexibility, speed of delivery and discoverability amongst a plethora of other measures.
There are several potential analysis errors that may crop up at this stage and go unnoticed.
- Changes to valuation criteria - Shifts in consumer preferences, needs and desires may rapidly shift the value of a resource. For instance, the ability to focus on mass production was seen as an order winner in the 1950s. For many industries today, mass production has taken a backseat to the ability to fulfill just-in-time ordering and customized requirements.
- Opportunity costs - The exploitation of one resource may hamper the exploitation of another. For instance, a company may see production speed as a powerful value driver. Yet, a focus on speed may require a reduction in other value drivers, such as quality or customizability.
- Cost of exploitation - The accounting costs of exploiting a given resource may be unknown or extremely high. The actual costs associated with the use of a given resource may require additional research.
- Network effects - The value of some resources depends upon customer adoption. Such items will necessarily have some component of risk that must be considered. For instance, the value of a telephone in a world without any others is zero. Yet its value rapidly rises as more and more telephones are sold. At this point in time, a (cellular) phone is considered a near necessity - a far cry from the item's value when first introduced.
- Underemphasizing the value of intangible resources - Something as difficult to describe as customer goodwill, tacit knowledge, vertical integration, or workforce enthusiasm is relatively easy to ignore. This is especially true when the positive effects of that resource act as a lagging indicator of company success.
- Other effects external to the framework - For instance, changes such as demographic shifts can radically alter the value provided by real estate. A storefront in the heart of Detroit might have been seen at one time as a valuable resource for a given business. Now it would be seen as a liability.
- Misunderstanding of value - There are many stories of missed opportunities and squandered potential due to a lack of vision or understanding.
Is the Resource Rare?
It is not enough for a resource to be valuable. It must also be rare. The world is awash in many items that prove exceedingly valuable, yet are free to any who wish to possess them. Common examples include such resources as sunlight, oxygen and gravity.
However, the more rare a valuable resource, the more strategically important it becomes to any who possess it. At the extreme end of the spectrum, a single company may be the only firm in the entire world that has access to a valuable resource. All things being equal, such a position could provide it with extreme strategic advantage.
It is vital to note that resource rareness is not static. Rather, it can be altered through artificial means including positioning and branding. A narrowing of definitions in the minds of consumers can cause common goods to become rare.
Bottled water companies, for instance, commonly take municipal (tap) water, rebrand it with unique names and declare the resulting product as a rare resource not to be found from any other vendor.
Other firms have found great success by incorporating relatively superficial changes to their resources. Minor shifts in packaging, language and appearance can remove much of the competitive landscape. A company producing a numerical software system, for instance, may be able to target a specialty market by labeling its product as a numerical software system for the nautical industry.
- Mistaking the rarity of a resource for the rarity of the effect of that resource - A manufacturing firm may employ the greatest machinists in the world, but if other firms can automate production via mechanization, the rarity of human capital may not offer any advantage.
- Mistaking relative rareness for actual rareness - An item that is rare in one geographic location, business or sector may not be rare in the market as a whole.
- Not considering the effect of close substitutes - De Beers and others involved in the mining of diamonds face increasing pressure from the introduction of artificial diamonds.
Is the Resource Difficult To Imitate?
A rare, valuable resource has great potential, but only if it remains both rare and valuable. In many cases, a firm can come along and simply imitate (or replicate) that resource.
There are some items that are impossible to imitate by definition. There is only one copy of da Vinci's Mona Lisa. No matter how much a painter may try, he will never be able to create an exact duplicate. Other characteristics can similarly be safe from imitation. For instance, there can only be one oldest vineyard within a country.
Nevertheless, for many valuable resources, the quantity available will continue to increase over time. Skills can be acquired, new suppliers can enter the marketplace, alternative sources of supply can be opened, and customer demand can be satiated.
Even the aphorism "land is a great investment, because they're not making any more of it" ceases to ring true on a long enough timeline. One can travel to the volcanoes of Hawaii to see that land is, in fact, being made on a slow, but regular basis. In a few tens of thousands of years, it might even be ready for purchase.
The fear of imitation has caused many businesses to attempt to limit imitation through artificial means. Two of the most popular are regulatory capture and government licensure. For instance, the South Sea Company was granted a monopoly by the British government for trade with South America in the early 1700s. Its license prevented direct competition and, thus, limited the ability of other enterprises to imitate. Other forms of legal privilege such as copyrights, patents and trademarks can be used to similar effect.
- Losing sight of efficiency of imitation - High fixed costs for resource exploitation may prove an excellent barrier to imitation for the first mover. In many cases, the question is not one of whether a resource can be imitated, but whether it is strategically desirable for another firm to do so.
- Ignoring temporality - Many resources may only be inimitable in the short term. For instance, possession of radio spectrum rights, patent rights, and agreements may have limited terms. Similarly, the time required for other firms to re-skill, retrain, mechanize or adapt may be extensive, but not infinite.
- Taking the word imitate too literally - There are multiple methods for acquiring resources. Recreating and re-sourcing are two methods. Acquiring control from the original party is an often forgotten third. In many cases, substitution of a similar resource or a dissimilar resource with similar effects may prove another means of competition.
- Not considering the cost of maintaining inimitable status - Some resources are passively inimitable and require no cost to maintain their status. Others require active and ongoing expenses. If an active method is employed, it is crucial to understand whether the costs of doing so exceed the benefits.
Can the Organization Exploit the Resource?
Up until this point, the VRIO framework has been an analysis tool for studying the strategic potential of a given resource at a generic firm. It is now proper to ask whether or not a specific organization can properly exploit that resource.
Many firms are inherently different from one another. Each has its own unique culture, product mix, strategy, customer base and resources availability. Thus, it should be of no surprise that a given resource considered vital to one firm may be nearly worthless to another.
In many cases, parties with resources that are valuable, rare, and inimitable find themselves best served by selling to an intermediary. Individual workers, for instance, often lack the marketing, capital and other resources to leverage the value to their own labors. Thus, they choose to sell their labors to companies, rather than to individual consumers.
- Cargo culting - Many managers believe that if one organization can find value in a given resource, their organizations can too. As discussed earlier, each firm will have its own unique set of needs and abilities which will cause the potential utility of a given resource to be different for each organization. Nevertheless, some managers will alter a firm's organization in order to best extract value from a given resource without considering the effects it will have upon the firm's ability to extract value from other resources.
- Stategic considerations - Even if a firm cannot exploit a given resource efficiently, there may be strategic reasons to utilize it in-house. For instance, vendors are increasingly discovering that the outsourcing of manufacturing comes at a strategic cost - the outsourcers often grow to the point at which they can compete against the firm.
- Ignoring leverage - It's common for parties to ignore leverage and only look toward efficiency. It often makes sense to partner with third parties who are better equipped to exploit a given resource. As an example, a furniture company would likely earn greater profits selling an advanced electron scanning microscope to a pharmaceutical company than using it as a quality control tool for itself.
- First-mover advantage - For better or worse, many firms will see first-mover advantage as all that is required to ensure inimitability. An early lead may allow a firm to capture a large slice of the market and spread its costs of exploitation amongst a large production volume. Of course, the opposite may hold true. Early exploitation may enable other firms to learn, adapt and figure out how to exploit the resource more efficiently.
- Maintenance - It may prove difficult for an organization to maintain its ability to exploit a given resource over a long period of time. Often, due to the scaling of an organization or shifts in internal politics and focus, a firm's internal workings may change significantly. What was once a core competency may be relegated to a neglected activity.
The VRIO analysis framework can be a powerful tool for understanding a firm's available resources and its strategic potential. Nevertheless, it is not a panacea. Rather, this framework should be merely one tool in many when attempting to understand the strategic direction of a firm.