Classification of Business Environment: Internal and External

After reading this article you will learn about the internal and external business environment. 

Internal Environment:

Survival of a business depends upon its strengths and adaptability to the environment. The internal strengths represent its internal environment. It consists of financial, physical, human and technological resources. Financial resources represent financial strength of the company. Funds are allocated over activities that maximise output at minimum cost, that is, optimum allocation of financial resources.

Physical resources represent physical assets such as plant, machinery, building etc. that convert inputs into outputs. Human resources represent the manpower with specialised knowledge that performs the business activities.

The operative and managerial decisions are taken by the human resources. Technological resources represent the technical know-how used to manufacture goods and services. Internal environment consists of controllable factors that can be modified according to needs of the external environment.

External Environment:

The external environment consists of legal, political, socio-cultural, demographic factors etc. These are uncontrollable factors and firms adapt to this environment. They adjust internal environment with the external environment to take advantage of the environmental opportunities and strive against environmental threats. Business decisions are affected by both internal and external environment.

 

The external environment consists of the micro environment and macro environment

1. Micro Environment:

“The micro environment consists of factors in the company’s immediate environment”. These factors affect the performance of a company and its ability to serve the customers. Micro environment consists of customers, suppliers, competitors, public and market intermediaries.

A brief discussion of the firm’s micro environment is as follows:

(i) Customers:

Customers constitute important segment of the micro environment. Business exists to serve its customers. Unless there are customers, business has no meaning. A company can have different types of customers like, households, producers, retailers, Government and foreign buyers.

(ii) Suppliers:

They supply inputs (money, raw material, fuel, power and other factors of production) and help in smooth conduct of the business. Firms should remain aware of the policies of suppliers as increase in prices of inputs will affect their sales and profits. Shortage of supplies also affects the production schedules. Firms should have more than one supplier so that change in policies of one supplier does not affect their production schedules.

(iii) Competitors:

Competitors form important part of the micro environment. Firms compete to capture big share of the market. They constantly watch competitors’ policies and adjust their policies to gain customer confidence.

(iv) Public:

“A public is any group that has an actual or potential interest in or impact on an organisation’s ability to achieve its interest”. Public can promote or demote company’s efforts to serve the market. The term ‘public’ consists of financial public (banks, financial institutions etc.), media public (newspapers, radio, television etc.), Government public, customer organisations, internal public (workers and managers), local public (neighbourhood or community residents) and general public (buyers at large). Companies observe the behaviour of these groups to make functional policies.

(v) Market intermediaries:

They are the links that help to promote, sell and distribute the products to final consumers. They are the physical distribution firms (transport firm), service agencies (media firms), financial intermediaries (banks, insurance companies) etc. that help in producing, marketing and insuring the goods against loss of theft, fire etc. Firms maintain good relations with them to carry their activities smoothly. All these factors are largely controllable by the firms but they operate in the larger macro environment beyond their control.

2. Macro Environment:

The macro environment consists of the economic and non- economic variables that provide opportunities and threats to firms. This is largely uncontrollable and, therefore, firms adjust their operations to these environmental factors.

The macro-environment consists of the following:

(a) Economic Environment:

The economic environment consists of economic forces that affect business activities. Industrial production, agriculture, infrastructure, national income, per capita income, money supply, price level, monetary and fiscal policies, population, business cycles, economic policies, infrastructural facilities, financial facilities etc. constitute the economic environment.

The economic environment influences the activities of business enterprises. In the capitalist economies, firms have the freedom to choose the occupation. The economic decisions to invest, produce and sell are guided by profit motives. The factors of production are privately owned and production activities are initiated by the private entrepreneurs.

In socialist economies, these decisions are taken by the public sector which is guided more by social welfare than profit maximisation. The economy is controlled by the central master plan prepared by the State. In a mixed economy, public and private sectors co-exist and singly or jointly own the factors of production.

Scarce economic resources are allocated over various business activities. Decisions regarding allocation of resources which respect to what to produce, how to produce and for whom to produce; nature of technology and the techniques of production, timing of production etc. differ in different economies. This constitutes economic environment of the economy.

The economic environment affects business in the following ways:

(i) Complete capitalisation or socialism does not exist. Free market economy and centralised planning exist together, though in varying degrees. In the world of liberalisation and globalisation, state planning is combined with free pricing to make macro-economic decisions for business entrepreneurs and welfare of society.

“The economy in which a business operates is not exclusively a free enterprise economy using prices and markets, but to some extent directed or in-directed by a system of planning, control, regulation and coordination.”

(ii) State controls the economy (or the business enterprises) through planning and regulation. It enforces upon business enterprises the responsibility of social responsiveness (responsibility towards society) by welfare-state principles enacted through legislation that enforce minimum wages, commodity control, fair trade practices etc. Legislative machinery promotes economic growth, efficiency and equity. Social responsibility is the outcome of business interaction with economic environment.

(iii) Some business firms are positively affected by the Government policy while others are negatively affected. A restrictive import policy, for example, protects home industries but liberal import policy can harm the domestic industries.

(iv) The incentives and disincentives provided by the Government affect business enterprises in many ways. To enjoy the economies of scale, firms establish the business in large cities but the Government promotes them to establish their units in backward areas by providing various tax incentives. The economic environment of a country, thus, removes regional disparities and promotes equitable growth of the economy.

(v) By providing incentives in the priority sector that produce essential goods for the economy, the Government promotes industrial sector of the economy.

(vi) Modern economies are open systems. The economic environment of one country affects the economic environment of another country. Multinational corporations operate world-wide and provide a number of benefits to host countries and home countries. This has developed science and technology and unified the world economy.

The economic system helps in answering questions like:

1. Is it the right time to set up the business?

1. Can new products be added to the product line?

2. Is the market size large enough to provide desired rate of returns?

3. Is the environment conducive in terms of availability of manpower, infrastructure, raw material, finance, building, plant and machinery etc.?

The economic environment, thus, plays vital role in shaping the culture of the economy. Market forces and State planning provide the constraints within which business enterprises carry out their functions. “Progressive management must keep itself continuously informed about the magnitude and direction of changes in national as well as international economic environment.”

(b) Non-Economic Environment:

It consists of socio-cultural, demographic, natural, physical, technological, political and legal environment that influence and are influenced by the economic environment. A large number of variables affect the non-economic environment.

Some of the important areas of non-economic environment are discussed below:

(i) Political-legal environment:

It is the legislative, executive and judicial environment of the country that shapes and controls business activities. The legislature describes the laws and courses of action to be followed by firms, the executive implements the decisions taken by the legislature (Parliament) and the judiciary ensures that legislature and executive function in the interest of the society. A stable political environment is conducive to business growth.

A business operates in the environment of Government regulations. Various laws are made to regulate the functions of business enterprises. They relate to standards of product, packaging of products, protection of environmental and ecological balance, ban on advertisement of certain products (liquor), advertisement of certain products with statutory warning (cigarette) etc.

There are laws to prevent restrictive trade practices and concentration of economic power in few hands. Regulations promote entry of firms in backward areas and products are reserved for small-scale sector. Liberalisation policies have allowed the Indian industries to operate in international markets and foreign companies to operate in Indian markets. This allows growth and diversification of markets and access to advanced science and technology for Indian entrepreneurs. At the same time, it threatens the small Indian companies that cannot compete with large foreign companies.

The political-legal environment provides a host of laws and regulations that affect the business affairs. It provides opportunities, threats and challenges for the business enterprises. The Government interacts with business enterprises at the local level, State level and the Central level and regulates their functions through various rulings.

Government interacts with the business in the following ways:

1. As a regulator:

It regulates the affairs of the business by promoting activities in certain areas and restricting in others. These regulations prevent unhealthy competition amongst firms and protect consumers’ interests against false advertising and unfair trade practices.

The political and legal environment, thus, performs two important roles:

(a) Promotion role:

It stimulates business enterprises by providing incentives either to small-scale sector in terms of reserving goods for them which cannot be produced by large-scale business houses, big industrial houses to set up in backward areas, providing development facilities to industries (industrial estates, financing facility etc.).

(b) Restraining role:

Business organisations have to work within the legal framework of the country. Laws have to be obeyed and judicial interpretations have to be followed.

2. As a supplier:

It supplies resources to business concerns.

3. As a competitor:

It competes with private entrepreneurs in areas like telecommunication, electricity, construction etc.

4. As a customer:

It supports business houses by buying their products.

Firms should have healthy interaction with the Government. They should indulge in activities that promote economic growth and know the legal system.

Some of the laws that exist in the country for smooth operation of business enterprises are as follows:

Economic Laws [Air (Prevention and Control of Pollution) Act, 1981; Consumer Protection Act, 1986; Essential Commodities Act, 1955; Foreign Exchange Management Act, 1999; Foreign Trade (Development & Regulation) Act, 1992; Industries (Development & Regulation) Act, 1951; Patents Act, 1970; Standards of Weights and Measures Act, 1976; Trade Marks Act, 1999],

The political-legal system helps in answering questions like:

a) Is the political climate stable in the country so that government policies do not change time and again?

b) Do the political organisations promote business activities, that is, processing of paper work is done without much delay because of bureaucracy and red tapism?

c) Is the judiciary effective in decision-making to deal with business conflicts and law suits?

d) Are the government policies conducive to business growth in terms of incentives, markets, taxation etc.

e) Are the licensing procedures for entering into a new business lenient or strict?

f) How conducive are the export and import policies to promote the imports and exports, etc.?

(ii) Socio-cultural environment:

It represents the values, culture, beliefs, norms and ethics of the society in which business enterprises operate. People are important to organisations both as human resource and customers. Their buying habits, buying capacities, tastes, preferences and education affect business enterprises.

Firms change their production and marketing plans according to consumer demand. The social environment consists of the social values; concern for social problems like protection of environment against pollution, providing employment opportunities, health care for the aged and old etc.; consumerism, that is, indulging in fair trade practices to satisfy human wants.

The cultural environment represents values and beliefs of the society. These beliefs mould the attitudes of people and help business enterprises determine their need perception. The socio-cultural environment helps firms support the social and cultural values of society by encouraging fine arts projects, sports, communication media, donations to educational, religious and charitable institutions, counseling centers, vocational and technical training centres etc.

The socio-cultural environment, thus, affects:

(a) Business objectives:

Social objectives are framed along with economic objectives as the society demands business organisations to look after their interests.

(b) Organisational processes:

Various organisational processes like motivation, leadership, control policies etc. are framed within the constraints of cultural system of the country. Workforce diversity is promoted, participative decision-making is encouraged, democratic leadership style is adopted as the employees demand so to promote their commitment towards the organisation.

(c) Goods and services to be produced:

Though business houses produce goods that earn them profits, it is equally important that these goods are desired by the society. Socially acceptable goods promote both business image and profits.

The socio-cultural system helps in answering questions like:

i. What are the expectations of society from the business?

ii. Can the business meet these expectations?

iii. Are social objectives part of the overall objective framework of the company?

iv. Do the business operations meet the ethical and value system of the society and if not, is the change possible etc.?

(iii) Technical environment:

Technology refers to application of scientific and organised knowledge to organisational tasks. It includes inventions and innovations regarding techniques of production. Technology is changing at a fast pace and technical environment is dramatically affecting the business environment either because of easy import policies or because of technology upgradation as a result of research and development within the country.

The technological advances have introduced products like robots, telecommunication facilities, medicines, equipment’s etc. Business firms adapt to the fast changing technical environment. Though technological changes can produce harmful effects also for the enterprises, firms try to reduce these effects and use technological changes in the best interest of firms and society. Not adopting technological changes is not possible; technical threats have to be converted into opportunities and gainfully employed in business operations.

The technical environment helps in answering questions like:

a) What type of technology is available in the environment and what type of technology is needed by the firm?

b) If the technology available is not suitable for the firm’s operations, does it need to import the technology or upgrade the indigenous technology?

c) At what rate are changes taking place in technology and how fast are they likely to result in technological obsolescence?

d) What is the firm’s financial strength in keeping itself updated regarding technological changes? etc.

(iv) Demographic environment:

It consists of population in its varied forms, such as gender, age, income, growth rate, language, religion, etc. Increasing population increases the demand for business products and also provides labour at low rate. A largely populated country can adopt labour-intensive technology to keep the labour force employed.

The age composition helps to produce goods to meet the needs of that group. Production is also affected by gender composition. More females will promote the enterprises to produce goods used by females. Labour mobility (from rural to urban areas and vice versa), their educational level, nationality, religion, etc. also affect policies of the organisations.

The demographic environment helps in answering questions like:

(a) What is the gender and age composition of the market?

(b) What is the income and education level of the consumers?

(c) How strongly do consumers believe in brand loyalty?

(d) How can the firm create patronage? etc.

(v) Natural environment:

The natural environment consists of the renewable and non­renewable resources used in the production processes. The renewable resources are air, water and solar energy which can be replenished and non-renewable resources are oil, coal, wood etc. which cannot be replenished.

Though air, water and solar energy can be replenished, firms are harming these resources by dumping industrial wastes in water and polluting the air and affecting the ozone layer. Increasing industrialization is affecting the natural environment by disposing off chemical wastes in land, air and water. It also affects the food supply which can be harmful on consumption. “The environment damage to water, earth and air caused by industrial activity of mankind is harmful for future generations.”

Business enterprises should use these resources wisely and adopt methods to restrict environmental pollution. Legislative measures are also enforced by the Government (Pollution Control Board) to protect the natural environment. Even the renewable resources should be used wisely so that rate of consumption does not exceed the rate of replenishment.

The natural environment helps in answering questions like:

(a) Are business activities conducive to natural environment?

(b) If not, are suitable measures taken to protect the environment?

(c) How far can the business follow the legislative measures in protecting the natural environment, etc.?

(vi) International environment:

It represents the global environment characterised by the “borderless world”. The Indian economy entered the global world in 1991 through its liberalisation policies. There have been significant economic and political changes and increasing role for the private sector to play since then.

The global business environment is significantly influenced by the principles and agreements of World Trade Organisation (WTO). WTO monitors and regulates the business transacted in the international environment.

It has created significant impact in the following areas:

1. Liberalisation of imports.

2. Opportunities for Indian firms to enter into foreign markets through exports and investments.

3. Seek foreign equity participation and foreign technology in Indian firms to expand business and improve competitiveness.

4. Facilitate global sourcing by Indian firms.

5. Benefit from global sourcing by foreign firms.

6. Improve efficiency and dynamism of the firms to survive in the global competition. Inefficient firms have to leave the market.