VRIN & VRIO
Identification of internal capabilities
I hope that all is well with you and yours.
Only a quick couple of words on the book club before we jump into today’s topic. Timeslot suggestions for the concluding virtual sessions have now been sent out. If you have not received an email, please let me know as soon as possible.
We will start the second read on our list – Life After New Media by Sarah Kember and Joanna Zylinska – on July 1st. Many of you have reached out and want to join for this book specifically, so let us hope it lives up to the great expectations (fret not, by all accounts it will and then some).
Now onto le sujet du jour: capability analysis.
Recollecting the Basics
For various reasons, capability analyses are often defined by contexts such as ‘process’ capability analysis, ‘exploratory’ capability analysis and so on. Although we will eventually get into such particularities, there is a point to first understanding the general before one gets into the specifics. So, that is what we are going to aim for today.
Capabilities can be defined as the firm’s capacity to deploy resources to achieve a desired end state (traditionally defined by a strategic plan). In other words, they consist of what is and what one can do as a result, the importance of which for strategy-making should be obvious.
The natural starting point is to look at what resources there may be, a topic which we have covered previously in critiques of resource-based view (RBV) of the organization and core competence, respectively. Much of it applies here.
To refresh our memories:
Firms within a sector may be (indeed often are) heterogeneous with respect to the strategic resources under their control. These resources can broadly speaking be categorized into:
physical capital resources (physical technology, hardware, a valuable geographic location of a factory or headquarters, access to raw materials etc.),
human capital resources (training that has been completed, accumulated experience, judgment, intelligence, relationships, insights of individual managers and workers, and so on), and
organizational capital resources (e.g., reporting structures, formal and informal planning, controlling mechanisms, coordinating systems, and informal relations in groups within the firm and between the firm and its environment).
Another way of describing the resources is as assets, either tangible (those which can be seen and quantified) or intangible (those that cannot). The former are, due to their nature, often rather easy to spot also from the outside and thus a common part of competitive analysis. The latter, however, are not – and it is this that can make them immensely valuable.
The question, then, is how to (even with the benefit of an insider’s perspective) unearth assets that might be of use in a strategic process. Well, the good news is that there are plenty of theories, frameworks and models claiming to do precisely that (and many are also coming up in the following weeks). The bad news is that the most common one – the VRIO framework – rarely does.
A Familiar Problem
VRIO (Valuable, Rare, Imperfectly imitable, Organizationally embedded) is an evolution of the VRIN model that we have discussed before.
Valuable resources are those that enable a company to conceive of or implement strategies that improve its efficiency and effectiveness (though what that entails tends to be conveniently omitted from discourse).
Rarity, as one might imagine, refers to the fact that a resource that is owned by a large number of competing (or potentially competing) firms cannot be a source for competitive advantage.
Imperfect imitability means that resources should be impossible for other firms to acquire or substitute for, which (in theory, logic and turn) is a prerequisite for any competitive advantage to become sustainable.
Lastly, the resource has to be organizationally embedded in such a way that the company can exploit it but others (competitors) cannot.
It all sounds rather simple in theory. Of course, it is a different matter entirely in practice.
Conveniently (or inconveniently, depending on where you sit), the resource-based view offers plenty of suggestion as to what strategically valuable resources might be, but no ideas of its own as to how to spot them. Instead, it relies on ‘environmental models of competitive advantage’ and SWOT analyses, both of which are rooted in industry structural perspectives and an outside-in view; they are concerned with the competitive positions that firms might occupy, not the nature of the specific resources required to achieve said positions. And when the V in VRIO therefore falls, so do the following letters.
Granted, they have their flaws too. As Ron Sanchez notes in a brusque critique, there are three fundamental deficiencies with the framework that render it incapable of systematically identifying which strategically valuable resources may become sources of competitive advantages:
1. The Uniqueness Dilemma
If resources are to create a sustainable advantage over the competition, it is not enough that they are rare in the sense that they are difficult to come by (as this implies that other companies could secure them if they only tried hard enough). Rather, they must be unique.
But, as I discussed in Strategy in Polemy, at some level of analysis, all (strategic) resources can be said to be unique as each context will differ from the next. If this is the case, all resources should by RBV logic be considered sources of advantage. This leads to the simultaneous conclusion that only unique resources create competitive advantages, but that all resources also are unique.
2. The Cognitive Impossibility Dilemma
As we know, firms are complex adaptive systems. This means that they are not causal, but dispositional. The RBV acknowledges this by referring to causal ambiguity and social complexity; it is by the very fact that managers cannot understand how a resource can be a source of sustainable competitive advantage that it becomes one (if they could, others would be able to as well). Unfortunately, from this follows that if a resource can be recognized as a source of sustainable competitive advantage, then it cannot be a source of sustainable competitive advantage.
3. An Asymmetry in Assumptions about Resource Factor Markets
For resources to provide a sustainable competitive advantage, the VRIO framework tells us that they have to be organizationally embedded, that is, effectively immobile; they cannot be or become available in factor markets. But the potential for a resource to create strategic value varies greatly depending on the company it might become embedded in – a Michelin star chef can make significantly more advanced dishes than a home cook with the same list of ingredients. Consequently, it is not the resource itself that creates the advantage but how it is exploited.
A Rule-of-Thumb Solution
Given that the resource-based view fails to provide any consistent approach to identifying resources that are strategically valuable in a firm, the VRIO framework becomes incapable of offering insight into which firm attributes are resources creating sustained competitive advantages and which are not.
A rather crude but (to some) acceptable solution is to therefore insert, as John Dawes points out in Marketing Planning and Strategy, two logic statements; to any asset that one has identified (in whichever way), one adds either ‘which means that’ or ‘relative to our competitors’. Importantly, neither of these addenda make any claims such as those made by VRIO (with the possible exception of valuable, though only implicitly).
To illustrate, a statement such as ‘we have a factory in China, which means that we can offer products at low prices’ says nothing about whether the same is true for the competition. Similarly, the sentence ‘we can offer products at low prices relative to our competitors’ does not equate to no other company being able to match the prices in question or even go below them. Both proclamations state what is and what one can do, and in so doing inform subsequent strategic decision-making – the entire point of the capability-diagnostic exercise. Having a factory that enables one to offer the lowest prices would certainly be an in-market advantage, but the fact that one does not might mean that one should instead consider creating best-in-class physical availability, for example. This strikes me as an acceptable, if extremely basic, first step at least for those not in need of granular detail.
At the end of the proverbial day, the definition of resource in the RBV is by explicit design so broad as to cover everything and thereby anything. Although one can argue, as proponents of the approach also do, that this allows for necessary contextual adaptation, it easily renders the exercise tautological. Resources cause competitive advantages, and anything that causes a competitive advantage is a resource.
In reality, it is not so much what a resource is as what one ultimately decides to do with it that matters. Strategic insights are only valuable if one has the requisite capacity to capitalize. Without also looking into the organization, there is no way of knowing whether one has.
But such insight will only ever be more or less partial; how deeply one digs depends on the task at hand. For some, it may be enough to identify the superficial and add a couple of logic statements. For others, that would be unacceptably insufficient.
Next week, we will continue our journey into the topic in hopes of unearthing what tools might be available for those with higher demands.
Until then, have the loveliest of weekends.
Onwards and upwards,