Few things are as difficult to write as a good introduction. To come up with a hook that ensures people retain their interest and are incentivized to read on is harder than it looks. So, in today’s article on the VRIO analysis framework, I would like to use a hack employed by a great many writers on the internet today and use a fake Einstein quote to pique your interest:
“New frameworks are like climbing a mountain – the larger view encompasses rather than rejects the more restricted view.” 1
In today’s highly competitive business landscape, organizations face the constant challenge of achieving and maintaining a sustainable competitive advantage. To achieve the desired results, it is important for them to use the right tools that can provide them with all mountain-like larger view.
One of the more useful frameworks which is criminally overlooked is the VRIO analysis. This framework is built on the belief that the key to success lies in effectively utilizing the internal resources and capabilities of an organization. To do so, it is necessary to be able to determine which of the firm’s resources are truly strategic and therefore form viable foundations to build a breakout success on.
The VRIO analysis provides a structured framework for evaluating a firm’s resources and determining their potential for creating and sustaining a competitive advantage. In this article, we will delve into the concept of VRIO analysis, its origins, its use cases, and how it can be applied to assess firm resources effectively.
In the following sections of this article, we shall examine the topics outline below:
- What is the VRIO Analysis?
- Why should you use the VRIO Analysis?
- Who invented the VRIO Analysis?
- Illustrating The VRIO Analysis with a Comprehensive Use Case
What is the VRIO Analysis?
Before we can go on and explain the reason behind our own appreciation of the VRIO Analysis, we first need to define exactly what the VRIO Analysis is.
We can begin by stating the obvious, namely that the VRIO analysis is a strategic management framework that assists organizations in evaluating their internal resources and capabilities. It offers a systematic approach to determine the competitive potential of a firm’s resources by assessing them on four distinct components. These are the resources:
We shall explain the specifics components more in depth in the next section of the article.
The Four Components of the VRIO Analysis:
This dimension examines whether a resource or capability adds value to the firm by enabling it to exploit opportunities, reduce costs, or mitigate risks.
If a resource fails to create value or if its value can be easily replicated or substituted, it may not contribute to a sustainable competitive advantage.
A good example of a valuable resource can be observed in the operations of the leading lights of the current generation of private space companies. Since the US became serious about opening the space industry to private actors, two companies have outpaced the others, namely Elon Musk’s SpaceX and Blue Origins backed by Jeff Bezos.
The two firms have a leg up on their competitors for many reasons, but the most significant paradigm shift they were able to effect was the shift towards reusable rocket technology.
Shooting rockets into space is a costly business, which has long scuppered attempts by private actors to get involved. By creating technology that allows for part of the rockets to be recuperated, the two companies have each been able to book unprecedented savings. This in turn has meant that companies that do not have access to reusable rockets are at a significant cost disadvantage, which has allowed Blue Origin and SpaceX to achieve their dominant position.
Rarity refers to the uniqueness or scarcity of a resource or capability within the industry or market. If a resource is rare, it becomes a source of competitive advantage because competitors cannot easily replicate it.
Rarity can stem from factors such as intellectual property rights, exclusive supplier relationships, or unique knowledge and expertise. Note that it is a rather meaningful characteristic for a producer to have a good understanding off, as an unexpectedly rare product can lead to all sorts of awkward situations.
An example par excellence of a ‘rare’ resource that was recently in the news are the tiny micro-OLED displays contained within Apple’s Vision Pro headset. The high expectations placed on the Vison Pro are almost entirely due to the great leap in immersiveness the headset can provide due to its use of the micro-OLED displays. Apple, however, seems to have bitten off a bit more than it can chew with its first production targets.
These stunningly expensive display units are an engineering marvel and so far, no producer is seemingly willing to take the risk of investing in the knowhow and manufacturing capacity needed to supply them sufficiently fast. This in turn has led Apple to slash its production targets for 2024 by as much as 60%.
A thorough VRIO analysis might have concluded that, while the micro-OLEDs undoubtedly give Apple an enormous advantage that is not easily reproduced by competitors, it is also not wise to depend on these display units without proper production capacity being in place.
Imitability assesses the difficulty of replicating or imitating a resource or capability by competitors. If a resource is easy to imitate, it may not provide a sustainable competitive advantage. Factors such as complex organizational processes, proprietary technology, or a strong brand reputation can contribute to the imitability of resources.
For Imitability, we decided to bring in an example from a bit farther afield in the form of the Chinese EV manufacturer BYD (Build Your Dreams). This car brand might not be a household name in the EU yet, but it has big international ambitions and a proven track record as it was the largest producer of electric vehicles in China in 2022.
Unlike what many European competitors were expecting, BYD has not restricted itself to the role of price champion. While its models are more than competitively priced, they are also full of technology that is as good (or even better) than what western brands like VW or Tesla have to offer.
Both its superior technology and its attractive prices are the result of high levels of vertical integration (BYD has amongst other things, its own battery and energy storage divisions as well as a computer chip unit), the absence of top-heave legacy organizations build around the construction of combustion engines and the fact that BYD is a Chinese company active in a market (that of electric vehicles) that the Chinese government itself has for years considered to be of the utmost strategic value.
Since the Chinese state is not afraid to use industrial policy to get what it wants, it has for years done everything in its power to nurture its EV industry. BYD has been the largest benefactor of this largesse and has been able to corner significant parts of the EV market in China.
It is from this position of strength that they will now seek to sally forth and gain market share around the world. For companies around the world, the type of factors that came together to enable BYD’s rise will be hard to replicate. As such, its Chinese base and customers, give it an advantage that is hard to replicate for companies outside of China.
The organization dimension focuses on how well a firm is structured, coordinated, and aligned to exploit its resources effectively. Proper organization involves aligning the resource with the firm’s strategy, ensuring the right talent, capabilities, and systems are in place, and establishing effective processes to leverage the resource for competitive advantage.
There are many examples that come to mind when we must illustrate this component of the VRIO analysis.
Some are not from the world of business and ended disastrously, like the case of Kitchener’s Army (i.e., the British Third Army at the Battle of the Somme), where incompetent commanders and feeble organizational structures that were ill-equipped to cope with the demands of industrial warfare led to calamity for many of the volunteers that had eagerly joined up to protect their country.
Others, however, did have more positive outcomes. To take one such example from the business world, we just have to look down our main streets. Chances are very big that when you do so, a conspicuous golden letter ‘M’ will be visible. The golden arches, as McDonalds’ is often referred to, is an American fast-food chain which has been able to establish a global footprint.
Now, McDonalds is a chain that has a lot of expertise in house. It knows what its customers are looking for, has a great range of products in its category and it has its branding down to a T. McDonalds, however, would never have been able to expand as fast it has done if it had not constructed its business around franchising. While McDonald owns some of its own restaurants, most of its income is derived from the 93% of its restaurants that are run by one of their many franchisees.
McDonalds strategy of co-investment with its franchisees (its most popular method) has allowed it to stretch its own resources much further and faster than if it had gone at it alone. By working together with the franchisee, McDonalds has been able to exploit its recipes and business model much more effectively than it could otherwise have done and has beaten competitors to become the world’s most well-known (and dare we say beloved) fast food brand.
Who invented the VRIO Analysis?
The VRIO analysis framework was introduced by Jay B. Barney, a renowned professor of strategic management at the Fisher College of Business, Ohio State University. Barney first proposed the precursor of the current VRIO framework in his 1991 paper titled “Firm Resources and Sustainable Competitive Advantage.”
Why should you use the VRIO Analysis?
Introducing the Red Queen Hypothesis
In the previous section, we have described what the VRIO Analysis is. This on its own however, does not spell out why the VRIO Analysis is such an important framework to have in your back pocket.
To explain that we turn to the work of one of the great writers of English literature, Lewis Carroll and the unlikely connection of his work to evolutionary biology.
Carroll is of course famous for his writings about a young girl named Alice, who falls through a rabbit hole into a fantasy world of anthropomorphic creatures.
What is often forgotten, is that there is actually a second book about Alice, in which she visits a world behind a mirror. In that book, the antagonist of the story is the infamous Red Queen (a chess-inspired antagonist, as can be deduced from the image below).
As it turns out, the Red Queen was a very quotable character. One of the people who was greatly taken in by the Red Queen’s role in Carroll’s story was the American evolutionary biologist, Leigh Van Valen.
In 1973, he borrowed the figure of the Red Queen from Carroll’s work and used it to formulate what came to be known as the Red Queen hypothesis. A companion to his earlier discovery of Van Valen’s Law (also known as the Law of Extinction), the Red Queen hypothesis revolves around the idea that in a competitive environment, species must constantly adapt and improve just to maintain their relative competitive position.
It suggests that competitors need to continuously evolve to stay on par with their rivals, similar to the Red Queen running in place to remain in the same spot. This concept in other words highlights the importance of dynamic capabilities and the need for ongoing adaptation.
Combatting the Red Queen
From literature to evolutionary biology and now back to strategy. It has always struck us how neatly this concept from evolutionary biology maps on to competitive dynamics in the corporate world. Truly, all companies are stuck in a Hobbesian competitive landscape, which creates a constant arms race between competing firms that never seems as if it can be decisively settled.
To give but one example, let us assume a competing firm X, which chooses to invest in its digital transformation. Firm X does so in the hope of gaining a competitive edge over competing firms Y and Z. Unfortunately for firm X, most competitive edges turn out to be shockingly brittle. The effects produced by an investment are either not large enough, or not long-lasting enough or both at the same time to make a real difference in the competitive landscape.
Since competing firm X investment in digital transformation does not lead to a killing blow, firms Y and Z can recover from any temporary setbacks and make the same or similar investments in competitive advantage to erode the small advantage firm X had been able to procure to its investments. In other words, ultimately a lot of exercitations are made without any great changes to the status quo.
Naturally, that does not mean that you should not as a firm invest in something like digital transformation. In the scenario outlined above, it is clear that without competing investments from Y and Z, firm X could have sneaked its way ahead of the others. The conclusion you should arrive at however, is that not all endeavours and investments are equally important.
To stage a breakout, you need your investments to pay off in a way that is either absurdly large, long-lasting and frequently both at the same time (e.g., Naspers purchasing 46.5 percent of Chinese internet company Tencent back in 2001, Google’s acquisition of YouTube in 2006 or Henry T. Ford’s introduction of the conveyor belt system for the production of his Model T.’s).
This is of course a tricky thing to do, as you can glance from the three blue-blooded examples given above. While there is no silver bullet for this problem, there are clearly a couple of methodologies that must be part of the arsenal to make a successful attempt at achieving the type of breakouts we discussed above.
In our view, the VRIO analysis is one of these methodologies. A thorough VRIO analysis, conducted by professionals such as the one we employ at SteepConsult, can absolutely help you discern where and when to invest your limited resources to have the greatest chance at achieving the kind of break-out success that could allow you to break free of the shackles of the Red Queen.
Illustrating The VRIO Analysis with a Comprehensive Use Case:
Now that we have introduced the central theoretical concepts, it is time to illustrate their use through a convenient use case. This must be seen as a compliment to the first section (what is the VRIO analysis) and will do more to elucidate the framework than a mere theoretical approach.
For today, we have decided to focus our efforts on Coca-Cola. We shall very briefly go through the VRIO Analysis and illustrate how this framework can help identify which parts of Coca-Cola’s resources are important to protect.
Naturally this small exemplar is not representative for the full effort that a trained team of consultants could bring to a case, but it is a good way to holistically show how the different sections of the VRIO analysis can fit together.
Important to note is that we consider Coca-Cola to be a company that has achieved a break-out. While it still has significant rivals (Pepsi co being the most famous) and many other more smaller challengers to boot, it is a fact that within the soda industry, Coca-Cola (and Pepsi Co) is a behemoth that has managed to attain a scale of success that other companies can only dream off.
While you can thus argue that Coca-Cola has thus already been able to beat the Red Queen, it is important to know that the hypothesis is never truly beaten. If complacency is allowed to set in, even a giant like Coca-Cola can be brought to its knees. It is therefore paramount for Coke to retain sight of what has made them so successful, so that it can nurture and grow that success and sustain its lead.
Let us begin by stating the obvious. Coca-Cola is a global leader in the beverage industry. Its dominance is the result of its history, but despite a deep well of customer attachment, its dominance is by no means guarantees.
To maintain its place at the top of the league, it needs to ensure that it possesses the right assets to contribute to sustaining its competitive advantage.
A quick VRIO analysis, conducted with an outsider-looking-in-perspective, reveals the following:
Coca-Cola’s brand value and recognition are immense. The Coca-Cola brand is highly valuable, contributing to its strong market position and customer loyalty.
Additionally, Coca-Cola possesses a vast distribution network and global reach, which adds value by ensuring its products are widely available to consumers worldwide. This global presence is supported by a strong product team, which manages to subtly attune the Coca-Cola offering to local tastes. All this together combines to give Coca-Cola vast advantages of scale, which are nigh on impossible to replicate for new entrants in the beverage industry.
The Coca-Cola brand is rare due to its long-established history, global presence, and strong consumer association. It is challenging for competitors to replicate the brand’s equity and the emotional connection it has built with consumers over the years. Not to mention that Coca-Cola’s monstrous scale has also allowed it to strong-arm many suppliers and retail partners in accepting terms most of its competitors outside of Pepsi do not have.
The Coca-Cola brand’s iconic status and reputation make it difficult to imitate. While competitors can and do produce similar beverages, replicating the brand’s legacy and the emotional connection it has with consumers is a significant challenge.
Coca-Cola’s organizational structure, marketing strategies, and supply chain management are well-organized and aligned. The company has a strong culture of innovation, allowing it to adapt to changing consumer preferences and market dynamics effectively.
The VRIO analysis provides a valuable framework for assessing the resources of organizations such as Coca-Cola. Every company, successful or otherwise, possesses resources. The company naturally hopes that these resources contain significant value, rarity, and imitability, so that they can then contribute to the competitive advantage of the firm if the organizational set-up around these resources is robust enough.
In the case of Coca-Cola, the company benefits from a highly valuable and recognized brand, extensive distribution network, and global reach. These resources are challenging to imitate and are well-organized within the company’s operations.
To maintain its lead, Coca-Cola will have to take many actions. It cannot forget to innovate and to enable it to do so, it needs to be aware on which foundations it should continue to focus. It does not make sense to focus on resources that cannot bring sustainable competitive advantage and could in the long-term not help it sustain the break-out it has been able to achieve and thus at least temporarily beating the Red Queen effect.
By leveraging the VRIO analysis, firms like Coca-Cola can identify areas of strength and areas for improvement, ensuring they remain competitive and continue to deliver value to their stakeholders in the ever-evolving business landscape. This might guide them in their open innovation efforts, their future strategic direction and many more important business decisions than we can lay out here.
Innovation & Change Management Consultant
After having amassed a wealth of experience in Innovation & Change Management, Arjan joined SteepConsult to support our transition towards an innovative, solution-oriented, and sustainable future. As our in-house intellectual, he enjoys sharing his knowledge with customers and colleagues alike.