Companies usually possess various kinds of resources and capabilities—financial, human, organizational, physical, and technological. For strategists, this raises the question as to which ones are so-called core competencies providing a source of sustainable competitive advantage. A good way to find out is the VRIO analysis which was first developed in 1991 by Jay B. Barney, the founder of the resource-based view, and since then repeatedly refined.
The acronym VRIO stands for four questions that help to determine the competitive potential of an organization’s internal resources and capabilities:
The basic question with which to start is: “Do resources and capabilities enable a firm to exploit an external opportunity or neutralize an external threat?“ As the exploiting of opportunities or neutralizing of threats is usually associated with profit increases and/or cost reductions, such a resource or capability could be considered valuable. If a resource or capability doesn’t add value, it is not a competitive advantage and may be outsourced. When the answer to this first question is “No,” there is no need for further analyzing this resource or capability.
“How many competing firms already possess particular valuable resources and capabilities?” If a resource or capability is valuable but not rare, the situation leads to competitive parity and no competitive advantage can be generated. However, not exploiting such resources may lead to competitive disadvantage.
“Do firms without a resource or capability face a cost disadvantage in obtaining or developing it compared to firms that already possess it?” If a resource or capability is valuable, rare, and costly to imitate or substitute, there is at least a temporary competitive advantage. Resources tend to be more difficult to imitate if: a) they are path dependent; b) there is an ambiguous relationship between the resources that enhance competitive advantage; c) they are socially complex (based on human relationships or culture); d) there are legal property rights, such as patents.
“Is a firm organized to exploit the full competitive potential of its resources and capabilities?” If a resource or capability is valuable, rare, and costly to imitate, but the firm is not capable to fully exploit it due to its formal and informal organizational and management structures, incentive systems, or culture, it is of little use. In this case, a reorganization of the firm may be needed.
Only if all four questions are answered “Yes,” a resource or capability compromises a sustained competitive advantage.
Fig. 1 VRIO analysis according to Jay B. Barney
The VRIO approach is particularly helpful in developing new business strategies by facilitating a systematic analysis and assessment of all existing tangible and intangible resources and capabilities along the organization’s value chain in terms of their importance for generating long-term competitive advantage. If helps to identify those existing competencies which a strategy should be based on and those it should not be based on.
At the same time, it provides valuable insights as to which competencies need to be kept, protected, or further expanded. To protect a competence additionally, companies can take different organizational and legal measures, such as increasing the costs of imitation, reducing transparency, or strengthening the enforcement of intellectual property rights. The management of internal resources thus becomes an integral part of strategic planning. In this respect, it is important to apply the approach regularly as the answers to the four questions usually change over time due to changes in the competitive environment.
VRIO analysis can be easily carried out using the strategic intelligence software SOLYP3.