I have had several visits to my blog post about how to correctly use Porter’s 5 forces and a few requests to write one on how to perform a VRIO analysis. VRIO is a complex and tricky framework to apply but it can lead to some great insights and help the firms identify strengths and weaknesses when applied correctly.
Like Value Chain, VRIO is a framework that is used for Internal Analysis of a business. VRIO is used to identify the unique capabilities and resources that are potential sources of sustainable competitive advantage. The keyword here is “sustainable”.
Resources: Resources are assets that represent inputs into a firm’s production process. For example, Capital Equipments, Skills of the workforce, brand image, etc. They can be tangible and intangible.
Capabilities: Capabilities are basically what a firm can do. A firm’s capability to integrate and deploy resources to attain the desired result. For example, Product Design, Supply Chain Management, etc. It is important to note that capabilities develop over time and reflect a relationship between tangible and intangible resources.
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VRIO Framework— 4 Criteria
VRIO framework suggests that resources and capabilities are a source of “sustainable” competitive advantage if and only if they are:
- Valuable — They help a firm exploit opportunities to create value for customers or neutralize threats in the environment.
- Rare — They are possessed by very few competitors.
- Costly to Imitate — It is difficult to develop by other firms. Conditions like first-mover advantages, causal ambiguity, social complexity, and culture can make resources and capabilities costly to imitate for competitors.
- Organized to be Exploited — The firm has the necessary mechanisms to implement.
So, we have to look at each resource & capability to determine if they are VRI and O.
Below is a summary of the VRIO model along with the competitive consequences and performance implication depending on a firm’s resources and capabilities meeting the 4 VRIO criteria:
It is important to note that you apply the VRIO criteria in that order to each resource and capability. Only if all four of the criteria meet is when you can determine that a firm has a “sustainable” competitive advantage.
Example — Louis Vuitton
Louis Vuitton is a very well known French fashion house and luxury retail company. Let’s analyze Louis Vuitton from a VRIO framework point of view.
Step 1: Identify the resources and capabilities
Resources: LV has certain resources like superior craftsmanship, highly skilled craftsman, and a unique heritage being a 150-year-old reputed brand.
Capabilities: Some of LV’s capabilities include quickly adapting to new trends and demand, efficient distribution through vertical integration of its distribution channel, etc.
Step 2: Apply four VRIO criteria
The above-mentioned resources and capabilities are valuable to LV to differentiate itself in the luxury fashion goods industry. Also, not a lot of competitors possess these resources and capabilities and therefore this is rare. Because of the unique historical conditions and being in the market for such a long time with a strong and reputed brand image, these resources and capabilities are costly to imitate for other firms. LV has been able to successfully exploit these resources and capabilities providing LV with a sustainable competitive advantage.
LV has certain unique resources like its brand image, the craftsmanship that is very valuable, not possessed by other competing firms, and is very difficult for a competitor to imitate and LV has been able to successfully exploit these resources and capabilities to see above-average returns for past several decades. A rich history and a brand image that is synonymous with luxury that is the most costly to imitate for competitors that results in Louis Vuitton having a sustainable competitive advantage. However, imagine if LV starts to make inferior products because they lost these resources and capabilities, they may see themselves with a competitive parity or a competitive disadvantage as other firms in the industry would gain a larger market share as customers’ willingness to pay a premium for LV products would decrease.
I hope this post was helpful in understanding what the VRIO model is and how to analyze a business through the VRIO framework. It is definitely a very tricky framework because it is difficult to have all the information required to compare a firm’s resources and capabilities with competitors.