The value chain, popularized by Michael Porter’s book Competitive Advantage, is a useful tool for taking stock of organizational capabilities.
Given that almost anything a firm possesses can be considered a resource or capability, how should you attempt to narrow down the ones that are core competencies, and explain why firm performance differs?
A value chain is a chain of activities. The goal of a value chain analysis is to identify processes in which the firm can add value for the customer and create a competitive advantage for itself, with a cost advantage or product differentiation.
Primary Value Activities
Inbound Logistics - acquire raw materials and resources and distributes to manufacturing as required.
Operations - transforms raw materials or inputs into goods and services.
Marketing & Sales - promotes, prices, and sells products to customers.
Service - provides customer support after the sale of goods and services.
Support Value Activities
Firm Infrastructure - includes the company format or departmental structures, environment, and systems.
Human Resource Management - provides employee training, hiring, and compensation.
Technology Department - applies management information systems to processes to add value.
Procurement - purchases inputs such as raw materials, resources, equipment, and supplies.
Products pass through all activities of the chain in order, and at each activity, the product gains some value. A firm is effective to the extent that the chain of activities gives the products more added value than the sum of added values of all activities. Examining the firm as a value chain allows managers to identify the important business processes that add value for customers and then find solutions that support them.
A company could survey their customers about the extent to which they believe each activity adds value to the product or service. The allows a business to measure each activities value according to consumers. The competitive advantage decision the company then faces is whether to:
Target high value-adding activities to further enhance their value.
Target low value-adding activities to increase their value.
Perform some combination of the two.
To lead to a sustainable competitive advantage, a resource or capability should be valuable, rare, inimitable (including nonsubstitutable), and organized. This VRIO framework is the foundation for internal analysis.
If you ask managers why their firms do well while others do poorly, a common answer is likely to be “our people.” But this is really not an answer. It may be the start of an answer, but you need to probe more deeply—what is it about “our people” that is especially valuable? Why don’t competitors have similar people? Can’t competitors hire our people away? Or is it that there is something special about the organization that brings out the best in people? These kinds of questions form the basis of VRIO and get to the heart of why some resources help firms more than others.
Moreover, your ability to identify whether an organization has VRIO resources will also likely explain their competitive position. In the figure, you can see that a firm’s performance relative to industry peers is likely to vary according to the level to which resources, capabilities, and ultimately core competences satisfy VRIO criteria.
Internal analysis begins with the identification of resources and capabilities. Resources can be tangible and intangible; capabilities may have such characteristics as well. VRIO analysis is a way to distinguish resources and capabilities from core competencies. Specifically, VRIO analysis should show you the importance of value, rarity, inimitability, and organization as building blocks of competitive advantage.