Review of the VRIO Framework & the Resource-Based View of the Firm

Review of the VRIO Framework & the Resource-Based View of the Firm

I. Resource-Based View of the Firm – the RBV has two key assumptions about resources and capabilities.  “First, different firms may possess different bundles of resources and capabilities.   This is the assumption of resource heterogeneity.  Second, some of these resource and capability differences between firms may be long lasting, because it may be very costly for firms without certain resources and capabilities to develop them.  This is the assumption of resource immobility.” 1

Bonita’s explanation – firms within an industry have different levels of financial performance.  In contrast to economists who take an industry view, strategists (and management teams) spend a lot of time trying to figure out why one company may have high returns (such as high returns on assets or on invested capital) and others may have low returns or even lose money within an industry.  Economists focus on industry structure (the number of firms in the industry, concentration of market share etc…) and make predictions about industry attractiveness and industry performance.  However, we know that even in unattractive industries, there are firms who earn good returns.   How can this happen?  RBV theorists believe that the variation in firm returns is a result of resource heterogeneity and resource immobility.  In other words, some companies have valuable assets or bundles of assets that others do not own.  Sometimes the other firms cannot afford to copy or find a substitute for these resources.  Sometimes the other firms cannot figure out exactly, which resources create the competitive advantage.

Examples: Nucor and the steel industry, Southwest and JetBlue and the airline industry.

II.    The VRIO Framework – given that resources and capabilities and the deployment of those assets are the sources of competitive advantage, we need some way to figure out which assets are the ones most likely to create a competitive advantage.  Firms have many assets, but which ones are the important ones?  How do we know?

We use a combination of industry (external analysis) and internal analysis to examine assets.  Doing an industry analysis using Porter’s Five Forces (see ch. 2) can help us understand industry dynamics.  A value chain analysis also helps us understand how the industry operates and the potential sources of industry profits.  Once we understand the external environment, we can examine an individual firm to see how it fits into the competitive landscape of the industry.  We use the VRIO framework (ch. 3) to evaluate a firm’s resources and capabilities in the context of competitive advantage creation.  SWOT analysis arbitrarily groups assets/resources into “strengths and weaknesses” but does not provide any context about competitive advantage.  In some situations “strengths” can be “weaknesses”.  Apple’s Steve Jobs is a classic example of the problem of looking at resources in this way.  Steve Jobs is an important “strength” for Apple.  However, the inability of Apple to function effectively under other leadership suggests he may be a weakness as well.  So how should we classify him – strength or weakness?  Compare Tables 3.3 and 3.4 on pages 92 and 93.

As managers, we use these tools (Porter’s Five Forces, Value Chain Analysis, VRIO Framework) to help us understand 1. the competitive environment; 2. our own firm’s sources of competitive advantage; 3. resources/capabilities that our competitors have and we don’t (but may need to acquire or develop in order to be successful); and 4. how we might change some of the elements of industry structure in order to either “build a moat” around our position in the market or increase our competitive effectiveness.

For example, we may discover through value chain analysis that a firm ought to control a piece of the supply chain in order to 1. ensure high quality inputs; 2. get more favorable input prices; or 3. disadvantage its competitors.  As a firm, it can possibly alter the industry dynamic by backward vertical integration.  Alternatively, buyers currently may capture a large portion of the total value in the product’s value chain.  In True Religion’s case, the firm opted to forward vertically integrate both to capture the huge retail margin and to disadvantage competitors by building the brand’s presence in product categories outside of jeans – thus, potentially adding to its reputational (brand equity) advantage, while also adding new sources of revenues

III.    VRIO framework and Competitive Advantage – in order for a resource or capability to enable a firm to create a competitive advantage, it needs to be
?    valuable (increase revenues, decrease costs or neutralize a competitive threat)
?    rare (be possessed by a fewer number of firms that the number required to create a perfectly competitive market); and
?    imperfectly imitable (be expensive to copy or purchase – defining expensive or costly as more expense than the benefit the firm could get by getting the resource or capability)

Moreover, the firm must be:
?    organized in such a way as to be able to use the resource/capability effectively

Wal-mart has a “strong culture” or a culture in which employees voluntarily adopt the company’s values and policies rather than just complying out of fear of reprisals from supervisors.  Strong cultures are associated with high levels of financial performance.  Part of the company’s unity of purpose stems from this strong culture and the centralized decision-making that accompanies it.  The company also has many valuable capabilities in purchasing, logistics, and other areas.  The culture enables WMT to get the maximum value out of its other resources and capabilities – except in international markets.  The company has failed in many international markets because those markets require flexibility and decentralized decision-making.  WMT is not organized in such a way as to be able to effectively employ the skills and knowledge of its employees in many international markets such as China.  A VRIO analysis of WMT’s culture when focusing on international markets might show that the company’s culture fails the “organization” test.

Challenges Associated With Using VRIO
Terminology – one of the biggest challenges with using the VRIO framework is the seemingly nebulous definition of the terms “rarity”, “imperfectly imitable”,  “temporary”, and “sustained”.  I will tackle each term in order to try to clarify the concepts for you.  However, uncertainty and relativity lie at the heart of strategy.  There are no “correct” answers in an absolute sense as there would be for an algebra problem, just bad, good, better, best types of answers.

Rarity – Barney & Hesterly define a “rare” resource as one that is possessed by fewer firms than it takes to create perfect competition dynamics (pg 85).   In my view, rarity is a “gray area”.  There are degrees of rarity.  For example, owning the rights to all of the oil fields in the North Sea would certainly qualify as rare as there are not many oil fields in the world, and no company owns the rights to all of them or even all of them in one geographic area.

But, what about brand equity in the premium jeans industry?  Is the True Religion brand rare?  This argument could go either way.  True Religion is the second or third largest brand in the category, and is much larger than most brands in the category.  The brand is unusually strong and rare.  However, there are at least 4 other companies with brands that also are strong in the category most notably, Seven For All Mankind and Citizens of Humanity.  So is True Religion “rare” in an absolute sense – no.  The brand meets the threshold of being rare as defined in the textbook.  Is it rare enough to create a competitive advantage for TRLG?  Apparently so, but you could characterize it as “somewhat rare”, because other firms have similar resources.

Imperfectly Imitable or Inimitable – the determining factors here are tie, and the trade off between cost and benefit.   Given enough time and money, nearly any resource or capability can be copied or acquired or a substitute can be found for it.  However, a resource or capability can be deemed imperfectly imitable if it will 1. take a lot of time for competing firms to develop or acquire; 2. if the cost of acquiring or developing the resource/capability will exceed the benefits competitors will get out of the resource/capability; and 3. if there are no good substitutes for the resource/capability or if
substitutes are too costly to purchase or develop.  The “I” in VRIO determines whether or not a valuable, rare resource may lead to temporary or sustained competitive advantage or just to parity.

So, which types of resources/capabilities are likely to be difficult/costly to imitate (imperfectly imitable) – leading to competitive advantage?  Those that:
?    are difficult to understand (causal ambiguity)
?    involve relationships (socially complex)
?    are a result of unique historic conditions
?    are a result of the way the firm developed (path dependence); and
?    patents (in a few industries such as pharmaceuticals)

Temporary vs. Sustained Competitive Advantage – the textbook defines a temporary competitive advantage as one that last for a short time (page 353).  What is short — a few minutes, days, weeks, perhaps a year or two.  A sustained competitive advantage is one that lasts for a “long period of time”.  Neither definition is precise.  You’ll have to use your own judgment.

** It would be helpful for you to review Table 3.3 on page 92 of the textbook.

VRIO Problem Examples

1.    Domino’s Pizza reformulates its recipe and upgrades its cheese, and improves its pizza sauce and crust.  Does the new pizza recipe have the potential to lead to disadvantage, parity, temporary, or sustained competitive advantage?  Why?

2.    Disney purchases Marvel Comics and plans to use the Marvel characters in its movie division to create “blockbuster” movies as well as in its merchandising business.  At some point, the company may add Marvel characters to its theme parks.  Does this acquisition have the potential to lead to parity, temporary or competitive advantage?  Why?

3.    Merck coordinates the efforts of its research and development scientists and its marketing department.  Is this effort likely to be a source of disadvantage, parity, temporary or competitive advantage?  Why?

4.    Procter & Gamble expands its Olay skin cream line to include anti-aging products.  One of its major competitors copies the line extension and claims its product is better.  Is this move likely to lead to disadvantage, parity, temporary or competitive advantage for the major competitor?  Why?