How to conduct a VRIO?

VRIO is the most common framework for analysing a firm’s strengths and weaknesses. Although it’s a fairly simple framework, I often see students apply it in the wrong way. This is most likely because they haven’t fully understood the theoretical background that is the basis of the framework.

In this post, I’ll explain what the purpose of the VRIO framework is and show an example of how to apply it in a project. Key points students should know after reading this post are:

• VRIO builds on the assumption that firms can gain a competitive advantage by having superior resources and capabilities
• The analysis looks at single resources and capabilities the firm owns, not at the firm itself
• The analysis should only look at key resources, not all the resources the firm owns. Remember the 80/20 rule!

The resource-based view

VRIO has its origins in a theory called the resource-based view. For those interested in understanding this theory at a deeper level I’d recommend reading Jay Barney’s seminal article “Firm Resources and Sustained Competitive Advantage” published in the Journal of Management in 1991. The main idea of the theory is that a firm with superior resources will have an advantage over its competitors and thus superior performance.

To understand why this would be the case, it’s best to consider an example from the famous economist David Ricardo. Consider a farmer who owns the most fertile land in the county. According to the resource-based view, the farmer with the better land has a sustainable competitive advantage.

This is so because the land is:

• Valuable as it gives them greater yields
• Rare as there is only a limited amount of fertile land available
• Inimitable as you cannot replicate its soil
• The farmer has full control over the land as he is the sole owner of the land.

Given that all these four factors are fulfilled owning the fertile land results in a sustainable competitive advantage to the farmer.

What does VRIO stand for?

I already touched on the meaning of the letters in the previous section but it’s worth to be more explicit about this.

• Valuable = Can the resource or capability give the firm an advantage in the market?
• Rare = Do competitors own a similar quality resource or capability?
• Imitable = Can others replicate the resource or capability?
• Organization = Does the firm have control over the resource or capability?

If all four of these criteria are fulfilled, then we would say that the firm has a sustainable competitive advantage. That is, like the farmer with fertile land, the firm can gain superior profits over a long period of time. If, however, only the V is true the firm would be at competitive parity. Whereas if V and R are true, the firm would have only a temporary competitive advantage; if V,R and I are true, then they would have an unused competitive advantage.

How to perform the analysis?

Now that we understand that the goal of the analysis is to identify key resources and capabilities with which the firm can gain a sustainable competitive advantage, we need to understand how to actually conduct the analysis. There are three key steps to the analysis:

1. Identify the firm’s key activities

Here, our main goal is to understand what activities the focal firm needs to perform. I would recommend using Porter’s value chain analysis to identify the firm’s key activities, as this gives you a logical structure to your analysis. A detailed explanation of how to perform Porter’s value chain analysis is outside of the scope of this blog post. But, briefly what you want to do is write up all the steps a firm needs to take to produce their product and service.

For example, to sell the iPhone, Apple needs to do sourcing, design, manufacturing, marketing etc. Some of these activities are outside of the firm, such as manufacturing in Apple’s case, so then you need to swap manufacturing for sourcing, that is the Apple needs to know how to find a high-quality manufacturer.

2. Identify the resources and capabilities the firm needs to perform the key activities

Once you’ve identified the key activities the firm needs to perform, you need to understand which resources and capabilities they need, to perform each activity. For example, for marketing, they need a strong brand, data on customers and advertising capabilities.

After you created a long list of different resources and capabilities you should narrow down the list into the 4–6 most important resources and capabilities. You want to cut down to only the most essential resources and capabilities to make it easier for the reader to focus on the most critical parts of the analysis. Remember the 80/20 rule, most of the time 80% of the performance is a result of 20% of the resources and capabilities. So, try to keep your focus on the most critical 20% per cent.

The process of choosing the key resources and capabilities is more of an art than a science. So, the cutting will be primarily based on your opinion. But it’s important that you develop a strong argument on why you chose this set of resources and capabilities, and if you can, you should also present some data to back up your list. The data can be something as simple as industry reports.

3. Perform the VRIO on each key resource and capability

Now that you have a list of resources, you need to appraise each resource and capability. This process is quite simple as the only thing you need to do is to take one resource at a time and answer the questions for VRIO that I presented in the section “What does VRIO stand for?”. Important here is that you go in order and start with V and end with O. If you conclude that the resources aren’t, for example, rare then you should end the analysis. That is, you do not analyse if the resource fulfils the criteria for inimitable and organization. This is so because, if the resource is not rare then we don’t care if it can be imitated or if we have full control over it.

When performing the analysis, you should also have a clear argument for why the resource is rare or inimitable. For example, fertile land is rare because only X per cent of the land in the country has this type of soil. You don’t need to include this information in your presentation or report, but you should have it available if someone asks.

Once, you’ve performed the analysis, you should summarise it in a table like the one below. After that, your VRIO is done.

Conclusion

This post aimed to give guidance to business school students and management consultants on how to perform a VRIO analysis. In the post, I explained both the theoretical foundations behind the VRIO and gave some simple instructions on how to conduct the analysis. If you want to learn about using the VRIO framework to create strategic recommendations for the firm, I’d recommend you have a look at my post on how to perform a SWOT analysis (see link).

If you have any questions, please let me know in the comments.