Core competences and VRIO analysis: find the advantage that lasts

Ask your management team one question: if a competitor had unlimited money, what could it still not copy within three years? The first answers are usually quality, service and good people. Those are strengths, and most competitors claim the same. A core competences and VRIO analysis separates what is genuinely hard to copy from what is simply good.

Both models come from the resource-based view of strategy: competitive advantage comes from what a firm has and can do, as much as from where it stands in the market. They complement the external analysis and turn the long list of strengths from your internal analysis into a short list you can build a strategy on.

The resource-based view: Barney in two steps

Jay Barney laid the foundation in the Journal of Management (March 1991). He started from two assumptions: firms differ in the resources they control, and those differences can last. A resource can then be a source of sustained competitive advantage when it is valuable, rare, hard to imitate and without a substitute, known as VRIN. In the Academy of Management Executive (1995), Barney turned this into a practical test, VRIO, replacing the question about substitutes with a question about the organisation: is the firm set up to use the resource?

Only four yes answers give a sustained advantage. Imitation tends to be hard when a capability has grown over years, when nobody can say exactly why it works, or when it rests on relationships and culture rather than on a machine anyone can buy.

Core competences according to Prahalad and Hamel

A year before Barney, C.K. Prahalad and Gary Hamel published "The Core Competence of the Corporation" in Harvard Business Review (May 1990). They describe core competence as the collective learning in the organisation, especially the ability to coordinate diverse production skills and integrate streams of technology. Competences feed core products, which feed the end products customers buy, much as roots feed the trunk and branches of a tree. Their three tests:

• Several markets: the competence gives access to a wide variety of markets.
• Customer benefit: it contributes noticeably to what customers value in the end product.
• Hard to imitate: competitors cannot easily copy it.

Few companies have more than a handful. A list of ten core competences usually means the team has listed strengths.

Resource, strength or core competence?

A strength is an outcome; a core competence is its cause. Porter's value chain helps find the causes, because a competence usually spans several activities.

How to find your core competences in five steps

1. 01

   Start with the customer

   Ask customers and lost prospects why they choose you or not. Write the reasons down in their words.

2. 02

   Make an inventory

   List resources and capabilities: physical assets, finance, people and know-how, routines, relationships and reputation.

3. 03

   Find the roots

   For each customer reason, ask which capability causes it. Look for capabilities that recur across products or markets.

4. 04

   Test with VRIO

   Answer each question with evidence rather than opinion, and ask an outsider, such as a customer or adviser, to challenge every yes.

5. 05

   Choose and assign

   Keep one to three competences, give each an owner and a budget, and decide where your strategy will use them.

VRIO analysis example: a sheet-metal fabricator

Kestrel Metalworks employs 120 people and makes housings and frames for machine builders and medical equipment makers. Two customers together account for 40% of revenue. A team of three engineers works with customers on new parts.

Fictitious Firmfocus example. V = valuable, R = rare, I = hard to imitate, O = organised to exploit.

The machines are what everybody has. The certification takes a competitor real time and effort, so it buys a lead but no more. The engineering team is the core competence: it explains the short prototype times, the low reject rates and why the two large customers stay. It is also the biggest risk, because engineering is not offered as a service, does not appear on quotes and is not billed.

The three engineers spend about 60% of their time designing for customers. At 1,500 productive hours each, that is 2,700 hours a year, worth €229,500 at €85 an hour, given away to win production orders. That is what a "partly" in the O column costs.

Fictitious Firmfocus example. The calculation works in any currency.

How to build and protect a core competence

Teece, Pisano and Shuen (Strategic Management Journal, 1997) added the question of renewal. They describe the firm's ability to integrate, build and reconfigure internal and external competences, and analyse it through processes, positions and paths: how the firm works, what it holds and the route that brought it there. A competence that is not renewed turns into a habit.

• Spread the knowledge: pair juniors with the people who carry the competence and write down the routines that can be written down.
• Organise the O: build the competence into quotes, prices, sales conversations and job descriptions, so it earns money.
• Keep the root in-house: outsource around the competence, never the competence itself.
• Invest separately from orders: give it time and budget that do not depend on this month's workload.
• Protect what can be protected: contracts, confidentiality agreements and intellectual property rights. The rules differ by country, so check them locally.

For Kestrel that means three moves: sell engineering as a separate design-for-manufacture service with its own price, train two junior engineers alongside the senior team, and use the competence to enter a third market, which also reduces the dependence on two customers.

Criticism and limits of the resource-based view

Kraaijenbrink, Spender and Groen (Journal of Management, January 2010) grouped the criticism of the resource-based view into eight categories. Its core message withstands five of them well, provided its variables, boundaries and applicability are specified. Three remain open: "resource" and "value" are hard to pin down, and the view of competitive advantage is narrow. In practice, watch for circular reasoning: the firm is successful, so it must have a core competence, so whatever it has must be that competence.

Pitfalls in a VRIO analysis

• Hindsight: calling whatever made you successful in the past a core competence.
• Yes to everything: a VRIO table filled in without evidence or an outside challenge.
• Outcome instead of cause: "fast delivery" on the list rather than what makes it possible.
• Forgetting the O: a competence that is valuable, rare and hard to copy but never priced or sold.
• Competence turning rigid: the skill that won the last market blocking the move to the next one.

Small business or larger organisation

The competences that survive the VRIO test go into the strengths of your SWOT analysis and shape the choice between Porter's generic strategies. All analysis tools are in strategic analysis, and the full theme is under Strategy.