Basic Business Principles: Evaluating Sustainable Competitive Advantage in Startups

May 28, 2013

Entrepreneurs understand that there are always business opportunities around them. In fact, there are usually more opportunities than an entrepreneur can handle. Many times, part of being a successful businessman is in understanding which opportunities to forego so that you can concentrate on the opportunities that make sense. When evaluating a startup situation, the entrepreneur should evaluate whether or not the new company has a good chance at establishing a sustainable competitive advantage. 

It is important to have a framework with which to evaluate new business opportunities. J.B. Barney provides a framework in his book, “Resource Based Theory: Creating and Sustaining Competitive Advantage”. Barney gives us the acronym VRIN that helps entrepreneurs decide whether or not it is worthwhile to start or be involved in a new company. Every company has a number of resources that they start with. If the resources match at least one of the following VRIN characteristics, it will have a higher chance of having a sustainable competitive advantage.

Valuable

This means that a company’s resources must be of greater value, in terms of relative cost to benefit, than competing companies. For instance, an engineer may figure out a way to create solar panels that deliver higher efficiency than competing companies. This would mean that his products are more valuable than his competitors, and it may be a basis with which to start a company that could maintain a sustainable competitive advantage.

Rare

This means that the company controls resources that are in high demand relative to the available supply. For instance, China controls a high percentage of the world’s rare-earth minerals, which goes into all sorts of electronic and industrial products. If a company were set up to manage these deposits, it would be in a great position because they hold onto a rare resource that is in demand by many companies.

Inimitable

Competitors will oftentimes rely on imitation as a way to catch up to the market leader. Companies that have resources that are difficult to copy have a better chance at success. Using the example of the solar panel engineer above, a venture capitalist may ask, what sort of patents do you have to protect your innovation? If patents have been granted, it is a way to ensure that the technology is not easily imitated. If no patent protection exists, then it is very easy for competitors to copy the new technology as soon as it is brought to market.

Non-Substitutable

Finally, when starting a company, you need to make sure that other resources cannot function as substitutes for your own. Solar panels fulfill a need in the marketplace for renewable and relatively inexpensive electricity. Even if you are able to come up with a design that is better than other products in the marketplace, and even if you have patent protection, you still need to be sure that there are no readily-available substitutes. In the case of the American solar industry, they are finding natural gas to be a very attractive substitute. It is very inexpensive, is relatively clean, and can even operate 24/7, something that solar panels cannot do.

When creating a company, be sure to consider whether the resources available fulfill the VRIN framework. If it does, it will increase your likelihood of creating a company with a sustainable competitive advantage. If your opportunity does not fulfill the VRIN framework, it does not mean that you cannot make money, but your competition will be tougher and your margins will be lower than if your company’s resources are valuable, rare, inimitable, or non-substitutable.

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