If you are looking for a strategy framework to think about a business’ competitive advantages, I recommend VRIO.
The name is an abbreviation of Valuable, Rare, Inimitable and Organized. Essentially, if a firm’s capability or resource is Valuable, Rare and Inimitable, and the firm itself is Organized, it has a sustained competitive advantage. The more sustained competitive advantages a firm has, the more robust its business model is and the more likely it is to succeed. Let’s take a look at a few real-life examples to see how applicable this framework is:
Apple is arguably the best in the world in combining hardware and software to produce great consumer products. Such a capability is absolutely valuable and rare because we don’t often see that in the market. Samsung or Huawei can make good hardware, but they don’t put hardware and software to harmonious use like Apple does. Google owns Android and is excellent at software, but they aren’t known for their hardware prowess. The fact that some of the biggest companies in the world haven’t been able to copy Apple means that this capability is hard to imitate. Plus, Apple, since Steve Jobs return, has been well-organized to leverage this capability with one P&L to promote singular objectives, the sway that the Industrial Design has or the new multi-billion dollar campus to encourage creativity and collaboration. Lately, Apple has bolstered this competitive advantage further with its own chip M1 and the rumored initiative to design its own 5G cellular chip. It’s precisely the ability to combine humanity, hardware and software that makes Apple products astounding success and itself the most valuable company (as of this writing).
Another advantage that Apple possesses is its world-class supply chain. Not many companies can operate a complex supply network that spans the world and have bargaining power over even powerful players like Foxconn, TSMC or Intel. Imagine that you have to work with suppliers in different countries for different parts, navigate through local regulations, coordinate delivery and transportation, and negotiate pricing while protecting the confidentiality of products. It’s monumentally challenging, but on the other hand, it’s valuable, rare and hard to imitate. Any new rival will have to spend years to put up the same network, and even then, it likely doesn’t have the power of Apple. Additionally, is Apple organized to leverage this capability? Tim Cook, the current CEO, is a supply chain wizard. The company COO, Jeff Williams, is also an Operations guy. The company is one of a few from the West to have a productive relationship with China and its government, despite all the political tension between the U.S and China. This type of relationship can’t be replicated in a short amount of time, if it can be replicated at all. Hence, supply chain is another sustained competitive advantage that Apple has to offer.
Aldi is a hard-discounter chain that originates from Germany and came to the U.S in 1976. The former CEO and President of Walmart, Greg Foran, labeled Aldi as “good and fierce”. What makes Aldi so? The discounter’s sustained competitive advantage lies in its long-standing culture and commitment to cut costs and pass on savings to shoppers. Here are a few practices that Aldi employs:
On average, an Aldi store’s size is about 12,000 square feet, compared to Walmart’s 178,000 and Costco’s 145,000 square feet. The smaller size helps drive down either leasing expense (if the land is leased) or depreciation (if the land is owned), as well as energy costs. Regarding SKUs, an Aldi store, on average, carries 1,400 items compared to 40,000 items by a traditional supermarket. The much smaller store size and more limited item selection lead to fewer staff required. An Aldi store usually has only 3-5 employees, a significantly smaller number compared to how many employees are present at a store like Walmart or Costco. The limited item selection enables Aldi to focus on its offerings and negotiate favorable deals with suppliers to keep costs and prices low. Another benefit is that a limited assortment doesn’t require complex marketing promotions, meaning that there will be no cost on marketing materials and labor.
Walking into an Aldi store, you won’t notice many decorations. It looks like an ordinary, no-fancy store and it’s by design to keep costs low. At Aldi stores, there is no free bag. Customers are encouraged to bring their own bags. Carts can only be used with a quarter coin. Customers retrieve the quarter upon returning a cart. This policy has long been part of Aldi’s signature operations. Additionally, customers have to bag their own groceries. A cashier will scan items and put them in a cart, but shoppers will have to take it from there. It speeds up the checkout process, increases efficiency and reduces the need for additional staff. As far as I know, there is no self-checkout.
About 90% of Aldi’s items are private labels. This private label centric approach allows Aldi total control over its selection and reduces the cost as well as complexity that comes with national brands. Private labels used to be unpopular among shoppers due to their cheap image. However, consumer preferences have changed. Astute shoppers, especially millennials, now have a much more favorable view on private labels because they are cheap and provide best value for money. According to Bain, 85% of American shoppers are open to buying private labels.Source: Onepercentamonth
It’s certainly valuable to pass on savings to shoppers. While the practices themselves may not be rare, the commitment and the culture that enables consistent execution are. The frugal approach that empowers all the little things mentioned above has been nurtured and well-preserved since 1946 when the parent brand was founded in Germany. The only rival that has a similar mentality is Walmart. But the two chains differ in strategies. While Walmart has its hands in numerous cookie jars, Aldi’s bread and butter in the U.S is groceries in small stores with a small number of SKUs. In that segment of the market, I don’t see anyone with Aldi’s expertise and culture. As you can notice, it’s easy to copy a tangible element or an expertise of a business, but it’s much more difficult to replicate the intangibles like culture. Lastly, is Aldi organized? The brand is still one of the best, if not the best, hard discounters in various markets. In the U.S, it has been growing steadily since 1976 and becoming more popular among shoppers. So, I’ll say: yes, it’s organized!
Disney’s competitive advantage comes from its ability to consistently create excellent content loved by millions around the world. Any production studio can come up with a great movie or show once in a while. Disney is among a handful that can do it consistently. Take Spiderman: No Way Home as an example. It’s on track to net over $240 million in the first opening weekend while being the 27th Marvel movie since Iron Man in 2008. Over the last decade, Disney has dominated the list of highest grossing movies with hit after hit like Avengers: End Game, Captain Marvel, Infinitive War, Black Panther or Star Wars: The Force Awakens. While HBO is known for its quality outputs, even the famed studio isn’t as prolific as Disney. If you think about it, it’s all but nearly impossible to achieve what Disney has done, especially given that it owns the IPs such as Star Wars and Marvel franchise for eternity. Is it guaranteed to succeed long in the future? No. But Disney is more likely than any of its rivals to replicate its previous successes.
Another competitive advantage that this iconic brand has is its theme parks. Disney’s theme parks attract thousands of visitors around the world every year. As an important source of revenue and margin for the company, and a place for fans to connect with iconic movie figures, these theme parks are certainly valuable. However, they are not easy to create. Any company can pour millions of dollars into building and operating a park, but would they have the brand equity that Disney has with consumers around the world? Would they be able to lure enough visitors to make their park a financial success? To cultivate a brand or a cult like Disney does, a challenger needs to put out iconic content and characters year after year. That in and of itself is a monumental challenge that can’t be done in a few years’ time, if it can be done at all.
In short, VRIO is by no means the only framework to evaluate a business’ strength. We also have Porter’s Five Forces or Value Chain Analysis, just to name a couple. But VRIO is a very useful tool in analyzing a business’ competitive advantages and whether the business is great at anything it does. It’s one of my go-to tools when looking at a firm, as I demonstrated above. Hope this has been helpful for you.
Disclosure: I am long Apple and Disney’s shares.