In this article we will discuss about the top eight external factors affecting business environment. This article will further help you to learn about:
- Business Environment Factors
- Economic Factors Affecting Business
- Social and Cultural Environment of business Environment
- Impact of Technological Environment on Business
Top 8 External Factors Affecting Business Environment:
External Environment Factor Affecting Business # 1. Economic Environment:
Economic factors throw light on the nature and direction of the economy in which a firm operates. Consumption patterns are usually governed by the relative affluence of market segments. Therefore, while carrying out strategic planning exercises, the firm must focus attention on economic trends in the segments that affect its industry.
Low interest rates on personal savings, for example could compel individuals to equity and bond markets, leading to a boom for the capital market activity and mutual fund industry. At the national and international level, the firm must look into the general availability of credit, the level of disposable income and the propensity of people to spend.
Interest rates, inflation rates, unemployment rates and trends in the gross national product, governmental policies, sectoral growth rates of agriculture, industry infrastructure, etc., are other economic influences it must consider.
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The world is a small networked village. Most nations are interconnected and interdependent now—thanks to the rapid advances in technology all over the globe. As a result firms, everywhere, are compelled to scan, monitor, forecast and assess the health of economies outside their host nation.
When the US economy slipped into a recession in 2001 interest rates were cut. They were cut repeatedly with a view to stimulate global output growth. Interest rates on home loans have fallen to rock bottom levels—to spur demand for new homes.
Low interest rates are aimed at boosting up sales of consumer durables, passenger cars, electronic items, gold and jewellery etc. Any expansion of consumer expenditures should lead to increased industrial activity—stimulating demand for various other items.
1. Rate of Inflation:
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Likewise the current level of inflation can directly affect how quickly rise, which in turn, might squeeze corporate profits costs. Price inflation can destabilize an economy leading to slower economic growth, higher interest rates and volatile currency movements. If inflation keeps rising, investment planning becomes hazardous.
Further, the current level of unemployment can directly influence how easy or difficult it is to find the kind of people you require. Speciality retailers such as Ikea, Gap and Williams-Sonoma are aware of the impact consumer disposable income has on their sales. Current economic conditions, therefore, will impact how firms have to adjust their antennae to catch the right signals in time to avoid problems later on.
2. Exchange Rate Fluctuations:
Further, movement in currency exchange rates has a direct influence on a firm’s products in the global market place. For example, agricultural and petroleum products are hurt by the dollar’s rise against the currencies of Mexico, Brazil, Venezuela and Australia.
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A stronger rupee is hurting the bottom lines of software companies in India in recent times. European firms such as Volkswagen AG, Nokia Corp, and Michelin complain that the surging Euro is hurting their financial performance. A weak dollar is prompting many nations to lower interest rates and loosen fiscal policy—and thereby stimulate economic expansion globally.
A low or declining dollar reduces the threat from foreign competitors while creating opportunities for increased sales from overseas. When exchange rate changes happen with frustrating regularity, managers need to take a serious note of this.
For example, when the Russian rouble was devalued in 1998 (causing even bread prices to rise to stunningly high levels) it was unfortunate for the Russian people because their purchasing power has contracted significantly.
The Russian companies have fallen behind in the competitive race, because they did not have enough buying power to buy products from abroad—which meant that the sales of foreign companies declined. At the same time, foreign companies suddenly woke to opportunity and realised how cheaply they could outsource raw materials, labour and so on.
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3. Ups and Downs in Economic Cycle:
Economic activity generally tends to move in cycles. It is difficult to predict exactly when an upturn or downturn in economic conditions will occur. However, the knowledge that such a danger is looming over the head would help managers plan their investments either locally or globally.
As the recent events have shown, the construction industry generally tends to have higher peaks and lower valleys than the overall national economy. When there is a mad scramble for scarce resources with a view to catch the upturn in demand for new homes, as it happened in recent times all over the globe, you are compelled to pay a price for the “irrational exuberance”.
4. Dynamic Changes in Economic Activity within a Country:
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Additionally, firms have to understand whether changes in the economy are temporary or whether they represent longer term structural changes. Structural changes are changes that significantly affect the dynamics of economic activity now and into the future.
The shift from an agrarian economy to an industrial economy and then from an industrial economy to a service economy were all structural changes that have enveloped most developed nations in the world. (Hitt et al) “They affected where people worked, what work they did, and the education level they needed to do the work and so on.
If structural changes are taking place and you are unaware of them, you can easily make poor managerial decisions”
Understanding the dynamics of global markets, developing appropriate strategies to move in line with changes in the domestic as well as global economies—keeping track of currency movements, interest rates, rate of inflation, cyclical nature of industry in which the firm operates, the growth rate of a particular nation etc.—is one of the toughest challenges confronting global managers.
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In the new global marketplace, managers are required to play challenging roles and create a competitive advantage for the firm through people-friendly policies and practices.
External Environment Factor Affecting Business # 2. Social and Cultural Environment:
The social factors that affect a firm include the values, attitudes, beliefs, opinions and life-styles of persons in the firm’s external environment, as developed from demographic, cultural, religions, educational and ethnic conditioning.
Like other forces in the external environment, social factors change continually. As social attitudes, beliefs and values change, so does the demand for various types of attire, books, leisure activities etc.
Let’s examine these factors in greater detail:
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1. Demographic Factors:
Demographic characteristics such as population, age distribution, religious composition, literacy levels, inter-state migration, rural-urban mobility, income distribution, etc., influence a firm’s strategic plans significantly. The entry of women into the labour market has, in recent times, affected the hiring and compensation policies of their employers.
This has also expanded the market for a wide range of products and services necessitated by their absence from their homes (such as convenience foods, microwave ovens, day – care centres, etc.). The shifts in age distribution caused by improved birth control methods have literally compelled producers to go after youth-oriented goods (beauty products, hair and skin care preparations, fitness equipment, etc.).
The growing number of senior citizens has made many a government to pay more attention to tax exemptions, social security benefits etc. Another important concern is the desire for a better quality of work life. Employees expect more from organisations than simply a pay cheque. They want cleaner air and water as well as more leisure time to enjoy life more fully.
2. Labour Mobility:
Across different occupations and regions, in recent times, has cut down wage differentials greatly. If labour is heterogeneous as is the case in India, managing people becomes a tough and demanding task.
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The explosive population growth during the last decade has serious implications for Indian government wanting to go after sophisticated technologies, discarding traditional, labour intensive methods.
The presence of a large number of English speaking engineers at the same time, has encouraged many software giants to set up shop in India. Cheap labour, rise in income levels and favourable governmental initiatives have made the Indian market more attractive to multinationals in recent times.
3. Cultural/Actors:
Social attitudes, values, customs, beliefs, rituals and practices also influence business practices in a major way. Christmas offers great financial opportunities for card companies, toy retailers, tree growers, mail order catalogue firms and other related businesses.
Social values refer to abstract thinking about what is good, right and desirable. Beliefs, on the other hand, reflect the characteristics of physical and social phenomena. We may believe, for example, that a high-fat diet causes cancer or that chocolate causes acne. Beliefs are important (whether right or wrong) in that they affect how we behave and what we buy.
For example, McDonald’s does not serve the beef burgers in India because Indians consider cows as sacred animals (Hindu tradition prohibits the consumption of beef in any form). Values and beliefs vary from culture to culture and before going ahead in a big way, companies must study the socio-cultural environment of a country thoroughly to avoid costly mistakes.
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To market soup in Japan, the manager/marketer must realise that soup is regarded there as a breakfast drink rather than a dish served for lunch or dinner. The loyalty shown by Japanese workers towards their employees, to take another example, is far greater than that shown by Indian workers for their employers. The distinction, obviously can be traced back to their respective socio-cultural roots!
4. Religious, Ethical and Moral/Actors:
India is a country where people belonging to almost all religious faiths live—Hindus, Muslims, Sikhs, Christians, Budhists and Jains. They speak different languages. With a population of over 1 billion and 65 per cent literacy level, the country offers exciting opportunities to marketers.
The country – specific risks in terms of corruption, political instability, vast cultural differences, poor infrastructure etc. are equally threatening. The ethical and moral roots of society are, however, very strong. People believe in joint family system (especially in North India), carry on prayers daily, believe in destiny, respect elders and senior citizens, perform rituals scrupulously, and are generally God-fearing.
The spread of consumerism, the rise of middle-class with high disposable incomes, the flashy life styles of people working in software, telecom, media and multinational companies and stock market addicts seem to have changed the socio-cultural scenario in recent times.
After the 90s, people have started rationalising the philosophy – ends justify the means. Such lower ethical standards have become a real threat now to business organisations which have traditionally been carrying out their operations in a fair way.
External Environment Factor Affecting Business # 3. Political Environment:
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Many political factors influence how managers formulate and implement strategic direction. Due to the socialist learnings of some of the ministers, Coca Cola and IBM had to move out of India in late 70s. A deep-seated fear of multinationals prevented political leaders to shut the door on giant multinational companies for a painfully longtime in India.
Barriers to entry protectionist policies, high tariffs, anti-nationalist slogans, bad publicity have had a cumulative effect in creating a closed economic model where people had to wait years together to buy a Bajaj Scooter or a Fiat car in India. When things turned bad to worse, the situation is sought to be remedied through a bold liberalisation programme in early 90s.
Apart from willingness to bend the rules and get along with the times, political stability is also essential for economic growth. After the Babri Masjid demolition in 1992, economic reforms again took a back seat and the then prime minister, P V Narasimha Rao could not carry on the bold liberalisation programme further.
The subsequent securities scam derailed the economy, all the more. Subsidies were never cut as planned at that time, public sector units could not be put on sale, Industrial Disputes Act remained intact, Urban Land Ceiling Act could not be amended (it happened finally in 1999), a National Renewal Fund could not be set up and the Insurance sector reforms remained in the basket.
Now small donations (imagine how cheaply Indian’s most powerful are willing to sell their souls!) to political parties – a mere $2127 in the case of the Bharatiya Janata Party’s Bangaru Laxman and $4,255 by the Samata party’s Jaya Jaitly for introducing arms dealers to higher-ups – have again come in the way of the bold economic steps proposed by NDA Government led by Vajpayee.
The Tehelka expose covering the whole shady deals on videotapes in the recent past has put a big question mark on crucial economic issues such as disinvestment, downsizing, de-reservation, labour reforms, power sector reforms, etc. Corruption, in recent years, has spread like cancer and even social activists like Anna Hazare, Baba Ramdev, Medha Patkar have not been able to get the government take effective steps to contain the menace.
External Environment Factor Affecting Business # 4. Legal Environment:
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The legal framework/regulatory environment is decided by the political party in power. The government, therefore, may legislate on matters like wage fixation, managerial remuneration, safety and health at work, location of plants, entry of multinationals, price control, import – export policy, licensing policy etc.
In a centrally planned and controlled economy like India, it is the government that lays down the rules of the game and the industry has to scrupulously adhere to the rule book.
Lobbying, political donations, public awareness campaigns still help in bending the policy stipulations a bit but, by and large, the levers of control are held by the ministers and bureaucrats only.
During the license-permit-raj that prevailed till late 80s, CEOs of most companies in India were expected to know the domestic market (only), know the government, make short-term plans, be able to handle diversified companies, and also implement the vision of the Babu, the owner (Team. C.D).
The family-owned businesses that existed wanted fixers, yes-men, collaborators and people with right connections with government officials. Licensing policies, quota restrictions, import duties, forex regulations, and restrictions on FDI flows, controls on distribution and pricing of commodities, regulations on all aspects of corporate functioning – have really put the captains of industry in a spot and pushed them to the wall.
A sort of love – hate relationship between corporate heads and bureaucrats prevailed for a frustratingly long time. The liberalisation measures macro-economic reforms and structural adjustments brought about in early 90s have altered the economic scenario quite dramatically.
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Obviously companies that want to do business globally must pay attention to the above developments closely and learn to adapt themselves to the laws of the land. The rules of competition, trademark rights, price controls, product quality laws, and a number of other legal issues in individual countries may be of special importance to global companies such as Coca-Cola, Unilever, IBM, and McDonald’s.
External Environment Factor Affecting Business # 5. Technological Environment:
Technological factors represent major opportunities and threats that must be taken into account while formulating strategies. Technological breakthroughs can dramatically influence organisation’s products, services markets, suppliers, distributors, competitors, customers, manufacturing processes, marketing practices and competitive position.
Technological advancements can open up new markets, result in a proliferation of new and improved products, change the relative cost position in an industry, and render existing products and services obsolete.
Technological changes can reduce or eliminate cost barriers between businesses, create shorter production runs, create shortages in technical skills, and result in changing values and expectations of customers and employees (F.R David). Technological advancements can create new competitive advantages that are more powerful than existing ones.
Recent technological advances, as we well know, in computers, lasers, robotics, satellite networks, fibre optics, biometrics, cloning and other related areas have paved the way for significant operational improvements.
Manufacturers, banks and retailers, for example, have used advances in computer technology to carry out their traditional tasks at lower costs and higher levels of customer satisfaction.
Consider the case of an old economy giant, Ford Motor Company, which is morphing into a new economy animal using web-based technologies to the best advantage (Anand). Thanks to the Internet, the old days of being able to concentrate only on the nuts and bolts of the business seem to be over.
The winners are going to be companies that move closer and connect well with customers. Take the stunningly successful case of MP3, a freely-available standard for the compression and transmission of digital audio.
The big guns of the music business – Sony, RCA and the rest – were so confident about their control over the music industry that they couldn’t see the threat posed by a tiny player like MP3.com, which quietly spun its own B-web.
The company didn’t try doing everything- the B-web had a combination of content companies (like MP3); manufacturers such as S3 (maker of the Rio MP3 player]; distribution technologies (like Napster); and, of course, hundreds of thousands of teenagers who swore by the music, but couldn’t pay for it.
Technological change, thus, can create or even decimate existing businesses or even entire industries, since it shifts demand from one product to another. Examples of such change include the shifts from vacuum tubes to transistors, from steam locomotives to diesel and electric engines, from fountain pens to ball points, from propeller aeroplanes to jets, and from typewriters to computer-based word processors [Wright].
Impact of Technology on Business Operations:
Technology is the means by which an organisation converts its inputs into outputs. Technology includes tools, machinery, equipment, work procedures, and employee knowledge and skills.
In the present competitive world, technological breakthroughs can dramatically influence an organisation’s service markets, suppliers, distributors, competitors, customers, manufacturing processes, marketing practices and competitive position.
In the past few decades, for example, optic fibres have facilitated communications, robots have changed the face of manufacturing completely, computers have facilitated the processing of enormous amounts of information, digitalization has enhanced sound and image delivery and lasers have replaced scalpels in various surgical procedures.
Technological advances can open up new markets, result in a proliferation of new and improved products, change the relative cost position in an industry and render existing products and services obsolete. Technological advancements can create new competitive advantages that are more powerful than existing ones.
Technology has helped Dell to survive and flourish in a competitive market without having to bother about inventories. The banking industry has been able to replace thousands of tellers with ATM machines and online banking systems. Organisations without dated technology are either shown the door or decimated quickly.
Many steel firms all over the globe were driven into bankruptcy because they were slow to adopt an important new process technology—called the electric arch furnace. For example, in the multibillion-dollar global disposable diaper industry, absorbency technology shifted from ‘fluff pulp’ (a paper based product) to absorbent chemicals.
This technological change was important because the absorbent chemicals could absorb more than fluff pulp and do so while making the diaper thinner. Procter & Gamble maker of Pampers, almost lost its dominant position in the U.S. marketplace because it didn’t keep up with the new absorbency technology that emerged in Japan! Furthermore, technological change in recent times has become increasingly diverse and complex.
Its pace is stepping up, making the executives more and more concerned with the adequacy of organisation structure (and new forms of organisation) to meet and match the needs. New technology will affect organisations in ways we cannot yet predict. It is not entirely without reason that mass customization is gaining popularity among leading firms too.
You can now buy clothes cut to your proportions, supplements with the exact blend of the vitamins and minerals you like, CDs with the music tracks you choose and textbooks whose chapters are picked out by your professor. Companies are able to make these bold moves because they are able to organise around a dynamic network of relatively independent operating units.
The Internet and the World Wide Web are changing the way companies and individuals communicate market, buy and distribute faster than organisations can respond. At Wal-Mart the electronic cash register indicates the goods sold, their prices and the inventory on hand. If the system recognises that a store is low on Tide detergent for example, an order is sent to the nearest distribution centre to send more Tide to that store.
If the distribution centre reports shortage of Tide, the system automatically generates an order to be placed with P&G for additional supply of Tide. Other retailers and even grocery stores, now-a-days use scanners linked to computers that provide instant inventory information.
External Environment Factor Affecting Business # 6. Natural Environment:
The natural environment comprising of ecological, geographical and topographical factors (such as natural resources, weather, climate, location etc.) are all relevant to business. Historically, Industries were set up in places where natural resources were available in abundance. This has created pockets of affluence, congestion and pollution all at the same time.
The natural endowments began to be used recklessly leading to air, water and land pollution and ozone depletion, gradually. Air pollution is created by dust particles and gaseous discharges that contaminate the air and cause global warming. Over the years, the growing number of coal-burning factories, thermal plants, automobiles etc. have precipitated the problem further.
Water pollution occurs mainly when industrial toxic wastes are thrown into the nature’s water ways. Land pollution is caused by the disposal of hazardous industrial toxic wastes in underground dumps.
The situation has become quite alarming in recent years when pollution levels have risen to unmanageable proportion causing serious damage to ozone layer – heating up the soil, water and air.
Thanks to environmental activists, many companies are now seriously trying to come out with-
(a) Eco-friendly products,
(b) Modified processes,
(c) Redesigned production equipment and
(d) Recycled by-products. Steel companies have been forced to spend heavily in cleaner – burning fuels and pollution control equipment.
The automobile industry has been asked to redesign engines that conform to strict emission control norms. The gasoline industry has been compelled to formulate new low-lead or no-lead products. And, thousands of companies have found it necessary to direct their R&D efforts towards finding ecologically superior products such as Sear’s phosphate – free laundry detergent, Pepsi cola’s biodegradable plastic soft drink bottle (Pearce and Robinson).
External Environment Factor Affecting Business # 7. International Environment:
International developments can greatly impact the ability of an organisation to do business abroad. For example, fluctuations of the rupee against foreign currencies influence the ability of an Indian company to compete in global markets. When the price of the rupee is high against foreign currencies, Indian companies find it difficult to compete in the international market.
Conversely, when the rupee falls against foreign currencies, new business opportunities open up. International factors influence domestic companies in another way, i.e. by producing new global competitors. For example, a number of technological advances pioneered in the United States have led to successful products.
Yet, in regard to such items as phonographs, colour televisions, audio and video tape recorders, telephones, semi-conductors, and computers, US producers have gradually lost a major share of the domestic market to foreign competitors, who took the basic technology and successfully built upon it.
International factors assume greater importance when domestic companies directly depend on (imports) or exports to certain countries. For example, the slowdown in US economy is impacting the fortunes of software exporters in India, who derive more than 60 per cent of their revenues from the Silicon Valley.
The dismantling of quantitative restrictions, to take another example, from 1.4.2001 is going to affect the fortunes of domestic companies manufacturing goods such as dry cell batteries, toys, stereos, telephone equipment, shoes, wrist watches, drinks and juices, chandeliers, colour televisions etc. (especially cheap imports from China).
Thanks to the advances in transportation and communication technology in the past century, almost no part of the world is cut off from the rest. The world is a big global village now and virtually every organisation, no matter what it offers and from which place it operates, is affected by international developments in one form or the other.
External Environment Factor Affecting Business # 8. Task/Competitive/Operating Environment:
The task environment is that part of the external environment consisting of specific outside forces with which an organisation interfaces in the course of carrying out its operations. It consists of the factors in the organisation’s immediate environment (micro-environment).
Usually, a single organisation has difficulty in exerting a direct influence on the external environment, but it may be more successful in affecting its own task or market environments. The various elements of micro-environment need not necessarily affect all the firms in a particular industry in the same way.
Important elements in the task environment of an organisation typically include:
1. Clients,
2. Competitors,
3. Suppliers,
4. Labour supply and
5. Government agencies (regulators).
1. Clients:
Clients include the customers, owners and partners of an organisation. The purpose of a business is to create and sustain customers. In an open market, the organisation turns into a lifeless machine without customers. We cannot think of hospitals without patients, universities without students, departmental stores without shoppers.
Organisations that stay close to the customer, survive and flourish in a competitive environment. Owners, shareholders and partners, too, have a stake in the continued success of an organisation.
They get appropriate economic returns on their investments. Additionally, they can exert greater influence on the way, the firm deals with environmental pollution, worker safety, product liability, etc.
2. Competitors:
Competitors’ actions and responses to them are key in determining whether a firm will prosper. Important data about competitors that should be examined from time to time include number of product lines, product differentiation, prices, quality, market share, advertising location, productivity, service, competitive advantages etc. Competition may be local, regional, national or international in scope, and this is constantly changing.
In higher-technology fields, competition can be fierce and turbulent. For example, computer companies have undergone dramatic changes and extremely tough product and price competition, within a rapidly expanding market.
In recent years, deregulation has changed the face of competition in several industries such as banking, airlines, media, telecommunications, passenger car industry etc.
3. Suppliers:
Suppliers of raw materials, equipment, parts and money are a very important part of an organisation’s external environment. Without a continuous flow of supplies, the organisation’s profitability will suffer. The energy crisis in the early 70s have affected the fortunes of many companies which depended heavily on petroleum for running their show.
Generally speaking, organisations must have sources of supply that are dependable in terms of quantity, quality, delivery, and service and that offer suitable prices and terms of purchase. Over-dependence on a single source of supply should also be avoided. The organisation should also be able to get credit on easy terms for its operations.
4. Labour:
The environment’s labour supply represents those individuals that may be employed to work for the organisation. All organisations need qualified, trained hands to take care of assigned duties.
This, in turn, is influenced by the economy, employment, socio-cultural factors, technological growth, unions, etc. The influence of unions in regulating supply of labour, when required, is diminishing in recent years due to recessionary trends, global competition, deregulation, disenchantment of members over limited successes achieved by unions, etc.
5. Regulators:
The task environment contains a number of government agencies that provide services and monitor compliance with laws and regulations at local, state or regional, and national levels. These regulatory bodies have the potential to control, legislate and influence an organisation’s policies and practices.
They also exercise considerable influence on the cost of doing. When doing business globally, the firm must also take into account the procedures to be adopted in line with the stipulations laid down by institutions such as IFC, World Bank, IMF, Environmental Protection Agency, etc.
Components of Internal Environment Organisations also have an internal environment which includes all the elements within the organisation’s boundaries such as human resources, resources, mission, culture, etc.
Factors Affecting Business Environment:
1. Political and Legal Environment:
The political environment of a region and country to which the business firm relates will have greater impact on its growth and sustainability. The political and legal environment of the rest of the globe will also have greater impact when the firm has extended its business operations across the globe. The government plays a vital role as the planner, promoter and regulator of business firms.
The form of government in position is an important aspect of political environment and political stability is an essential factor influencing the growth of business. The political and legal environment has a significant impact on the opportunities and threats for business organizations.
The philosophy of political parties in power influence business practices. The legal environment serves to define what organizations can and cannot do at a particular point of time. The pro-business philosophy allows to enter into arrangements like mergers, acquisitions, joint ventures, business alliances, outsourcing arrangements etc. in between the business firms across the globe.
The business and industry operate within the framework of the prevailing legal environment. The legal environment facing organizations is becoming increasingly complex and affecting business more directly.
The business firms are expected to have thorough knowledge of the laws of the land, rules and regulations, government policies etc. to reduce the political and legal impact on business firm. The concern for protection and conservation of natural environment has been subject to many regulations and policy changes in the recent past.
The political and legal factors that influence the business firms and industry are:
i. Political climate
ii. Political stability
iii. Political ideology and philosophy of political party in ruling
iv. Stand of opposition parties on business
v. Level of political morality
vi. Law and order situation
vii. Political attitude towards business
viii. Government’s attitude towards foreign business firms
ix. Corporate and personal taxation rates
x. Restrictions on international financial flows
xi. Legislation that favour business investments
xii. Controls on business frauds
xiii. Government debt
xiv. Import tariffs and quotas
xv. Simplicity of tax laws
xvi. Severity of employee welfare legislation
xvii. Environmental protection laws
xviii. Anti-monopoly laws
xix. Export restrictions
xx. Copyright and patent protection
xxi. Extent and nature of government regulation in business and economy
xxii. Regulatory calibre of government agencies
xxiii. Influence of political pressure groups
xxiv. Political influence on trade unions
xxv. Protection of special interest groups like consumers, women, minorities
xxvi. Simplicity and understandability of government legislation
xxvii. Consumer protection laws
xxviii. Environmental pollution control legislation
xxix. Government’s view on globalization and trade liberalization
2. Economic Environment:
The economic environment of business refers to overall state of the country/region’s economy. It has significant impact on the industry structure and profitability of individual firms. Economic factors refer to the character and direction of economic system within which the firm operates. The survival of business and industry largely depends on the purchasing power of people which is dependent on economic environment. The economic factors decide the nature and direction of the economy in which the firm operates.
The economic variables that impact the business and industry include:
i. State of business cycle
ii. Distribution of income within the population
iii. Government’s monetary and fiscal policies
iv. Trade restrictions
v. Money supply
vi. Industrial production
vii. Capacity utilization
viii. Unemployment
ix. Inflation
x. Growth in GDP
xi. Institutional lending
xii. Stock market movements
xiii. Monsoons
xiv. Productivity of factors of production
xv. Fiscal deficit
xvi. Credit/Deposit Ratio
xvii. Stock of food grains and essential commodities
xviii. Industrial wages
xix. Foreign trade and balance of payments position
xx. Infrastructure facilities
xxi. Economic and industrial policies of the government
xxii. Debt recovery and loans outstanding
xxiii. Interest rates
xxiv. Foreign investments
xxv. Trends in capital market
xxvi. Foreign exchange rates
xxvii. Government intervention in free market working
xxviii. Growth rate of economy etc.
3. Socio-Cultural and Demographic Environment:
The socio-cultural environment of business consists factors like social traditions, values and beliefs, level and standards of literacy and education, ethical standards and state of society, extent of social satisfaction, conflict and cohesiveness etc. which influence the industry structure, its success, growth and profitability.
The socio-cultural dimension of the environment consists of customs, life-styles and values that characterize the society in which the firm operates. The culture is the result of complex factors such as religion, language, education, ethical beliefs etc.
Demographic factors such as population growth, age composition, family size, family life cycle, income levels, religion, tastes and habits, education levels, birth rate, death rate etc. will have significant bearing on the strategic decision making. A social class is identified by income, occupation, life-style and class norms.
Socio-cultural components of the environment influence the ability of the firm to obtain resources, market its goods and services, and function within the society. Observing the socio-cultural and demographic factors enable to identify the opportunities and threats for the business organization.
4. Technological Environment:
The technological environment includes the changes in technology which can alter the firm’s competitive position. Technology and business are interrelated and interdependent. Technological changes bring many new opportunities as well as causing threat by making existing systems obsolete. The changing technology may affect the demand for a firm’s products and services, its production processes, and raw materials.
The technological developments need a careful and timely strategy formulation; otherwise competitors would take a lead in the market position. The advancement of technology can reduce or improve opportunities for a firm. Technological changes will bring in many new products as well as causing death of many existing products.
Organizations have been influenced by the technological changes and will be continually influenced by breakthroughs in future.
(a) Computing speed has impacted the organizations fundamentally. They have affected the design and manufacture of products, the way organizations communicate with suppliers and customers, and the way organizations are managed internally. CAD, CAM and CIM are classic examples of this.
(b) Information acquisition and dissemination has been greatly enhanced by the merger of telecommunications and computers. Revolutions are happening in the way Indian companies are communicating with their members, suppliers and customers almost instantly through gadgets.
(c) Internet technologies are changing the business models and challenging the traditional structures. Net enabled technologies are integrating with the business processes of the modern organizations.
The internet is acting as a national and even global economic engine that is spurring productivity. The internet is saving companies billions of dollars in distribution and transaction costs from direct sales to self- service systems.
The internet is changing the very nature of opportunities and threats by altering the life cycles of products, increasing the speed of distribution, creating new products and services, erasing limitations of traditional geographic markets and changing the historical trade-off between production standardization and flexibility.
It is also altering economies of scale, changing entry barriers and redefining the relationship between industries and various suppliers, creditors, customers and competitors. An emerging consensus holds that technology management is one of the key responsibilities of strategists.
The above four macro environmental factors have significant impact on the survival of business and growth prospects. These factors are external to the business and beyond the control of individual enterprise and their management. The external environment poses threats to a firm or offers immense opportunities.
A firm may be influenced by changes within the general environment but cannot itself influence the environment. The crucial part of the strategic planning process is the appraisal of the environment of an organization. The firm may use scenario planning techniques to forecast in high levels of uncertainty in external environmental conditions.
Factors Affecting Business Environment (5 Dimensions):
The business environment accordingly consists of five dimensions or components namely, economic, social, technological, political and legal factors, discussed in the following sub-sections:
1. Economic Environment:
Economic environment refers to factors related to economic policies, economic system, nature of the economy, economic cycles, distribution of income, economic resources, wealth, etc. This environment broadly reflects allocation of resources (financial, human and physical) towards satisfying overall human wants and needs in an economy.
Economic environment can be further categorised into Economic conditions; Economic policies and Economic systems, discussed as follows:
(i) Economic Conditions:
Economic conditions reflect the economic state of affairs that possibly influences economic development of country/industry/region/sector. Economic conditions can be realised from macroeconomic factors reflecting changes or improvements in lifestyle, purchasing power of people, consumption levels, etc. Conditions that lead to positive changes like decrease in unemployment rate, increase in GDP, price stability, etc., can boost business confidence and encourage businesses to plan activities leading to their growth.
(ii) Economic Policies:
Economic policies are courses of actions framed by the governments, which attempt to influence or control the behaviour of an economy. For example, the Reserve Bank of India (RBI) controls the interest rates of our country that influences rise in investment (with lower interest rates) or rise in savings (with higher interest rates) depending upon the nature of economy (RBI, 2015). Other policy related examples are changes in taxes, customs and excise duties, subsidies or grants to a particular sector or industry which facilitate either revival or expansion/improvements in a particular sector.
(iii) Economic Systems:
An economic system is an organised way in which a state or nation distributes and allocates its resources and distributes goods and services among individuals in an economy. The prevailing economic system can completely affect the vision, mission and objectives of business in that particular country.
There are three types of economic systems like capitalism, socialism and mixed economy. Capitalism emphasises on private ownership of capital and production inputs utilised for profit- making with limited interference from governments or regulations (Laissez-faire economy) and freedom to produce any product /services that is saleable in the market.
Countries like United States are capitalist economies. Alternatively, socialism focuses on collective ownership of means of production by government or state through a centralised planning system that is believed to create equality and provide economic security. Former Soviet Russia and countries like China, Vietnam and Cuba follow socialist economic systems.
An economic system, which consists of characteristics from both, capitalism and socialism, is a mixed economy. India represents a mixed economic system which allows economic freedom to the private sector and public sector coupled with government interference in the form of setting laws, regulations and policies.
2. Political Environment:
Political environment consists of factors influenced by government actions. These actions can be internal, national or local, which affects the operations of a business.
Political environment includes factors like:
(i) Political ideology, which is a certain sets of ideals, principles, doctrines, myths or symbols shared commonly by a group of individuals in a political system. For example, a political party believes in promoting swadeshi or domestically manufactured products/services rather than relying on imported goods.
(ii) Political stability is associated with security and safety provided by governments. In a political stable environment, there is certainty and confidence generated by governments that ensure with possible investment and expansion opportunities, consistent supply of financial, human and physical resources. Factors that may lead to political instability include – communal riots, civil war, state emergency, etc.
(iii) International relations which are concerned with foreign affairs of and relations among countries. These international relations are maintained as an attempt to reflect political stability.
(iv) Welfare activities of government that ensure the well-being of a country’s citizens.
(v) Defence and military policy that deals with international security and the military.
(vi) Centre-State relationship that defines the nature of relationship between Central government and State government in our current decentralised/federal system.
3. Technological Environment:
Technological environment is the development in the field of technology which affects businesses by new inventions and improvements in production and its techniques. Factors in technological environment attempt to boost businesses to produce/ provide cost-effective and innovative products/services. Technological developments in India have occurred by establishment of research and development centres in the field of agriculture, medicines and space. There have been technical policies formulated that enable import of technology from foreign countries.
Technological environment can be shaped and developed in terms of the following factors:
1. Level of technology, which can be labour-based or capital-based technology. In labour- based technology human labour is mainly used for operations and in capital-based technology automation, computerisation or robotizing measures are undertaken.
2. Pace of technological change, that determines whether existing technology in industries have become obsolete (e.g. power sector in India) or can be rejuvenated (e.g. Telecommunications in India). The pace of technology can also create entirely new industries or can increase government regulations. For example, import of Information Technology (IT) in the 1990s led to growth in outsourcing business models (BPO, KPOs, etc.) in India. Indian government has provided income tax exemptions for expenses incurred in research of technology.
3. Technological transfer, which is a transfer of skills, knowledge, technologies, methods of manufacturing, samples of manufacturing and facilities among governments or universities within and/or across countries. Technological transfer broadly aims at new product development, improvement in production or processes and customer satisfaction.
4. Research and Development (R&D), which is directed towards innovation, introduction and improvement of products, processes and services.
4. Legal Environment:
Legal environment refers to the microeconomic laws, regulations and / or legislations, which govern the operations and regulate businesses in India. Businesses need to abide by such legal aspects for obtaining access to human, financial and physical resources. The basis of these laws and regulation is to safeguard the interests of consumers, wages and prices, safety and health at work, location of the plant/factory, to facilitate investments and to preserve the environment in and around the business. There are three characteristics of legal environment-laws, courts of law, and law administrators.
Laws are a system of rules enforced on businesses which they should abide by while courts of law consist a government body that administer justice through law administrators (custodian, trustee, legal representative, etc.) who administer, execute and oversee the application of the laws in a business.
Components of legal environment that influence a business include:
(i) Controlling production- Laws and legislations aim at safeguarding the overall interests of the community and may accordingly regulate the production of products and services in a desired direction that leads to efficient utilisation of scarce resources of the country. For example, the Factories Act, 1948 and the Industrial Development and Regulation Act, 1951 address welfare.
(ii) Employee protection- There are laws aimed towards protecting the interests of workers that ensure fair business practices, hygienic and safe working conditions, fair wages, feasible and flexible working hours, benefits and so on. For example, Minimum Wages Act 1948 sets minimum wages for labour in specific sectors.
(iii) Consumer protection- As consumers, people are entitled to receive good quality products and services as per their expectations. Laws that protect consumers against duplication, adulteration, etc., against loss or harm to life and property are equally important. For example, the Consumer Protection Act, 1986 aims at protecting consumers from hazardous products/services, consumer exploitation from unfair trade practices, etc.
(iv) Environment protection- Environmental protection laws address environmental pollution, harm or depletion of natural resources like water, air, forests, minerals or fisheries. India has laws that protect wildlife under Wildlife Protection Act, 1972, Biological Diversity Act, 2002, Air (Prevention and Control of Pollution) Act, 1981, etc.
5. Socio-Cultural Environment:
Socio-cultural environment refers to a set of beliefs, customs, practices and behaviour that exists within a population. Businesses tend to study this environment to understand the nature of their customer needs and expectations. For example, residential construction companies in cities promote homes which are bigger than three BHK for attracting rich joint families.
Thus, factors under socio-cultural environment include:
1. Attitude of people to work.
2. Family system.
3. Caste system, religion, languages, marriage, customs and traditions.
4. Education.
5. Level of Urbanisation.
6. Habits, beliefs, lifestyles, tastes and preferences.
7. Social trends.
8. Business ethics.
External Factors Affecting Business Environment:
In undertaking environmental scanning, strategic managers must first be aware of the many variables within a corporation’s societal and task environments.
The societal environment includes general forces that do not directly touch on the short-run activities of the organization but that can, and often do, influence its long-run decisions.
The task environment includes those elements or groups that directly affect the corporation, and, in turn, are affected by it. These are governments, local communities, suppliers, competitors, customers, creditors, employees/ labor unions, special-interest groups, and trade association.
A corporation’s task environment is typically the industry within which that firm operates. Industry analysis refers to an in-depth examination of key factors within a corporation’s task environment. Both the societal and task environments must be monitored to identify the strategic factors that are likely to have a strong impact on corporate success or failure.
The societal environment comprises various external forces that significantly affect all products, services, markets, and organizations in the world. For a business enterprise the environment comprises political, economic, sociological, cultural, demographic, technological, legal, ecological and international factors.
1. Political Forces:
Political environment of a country has a bearing on the operation of a business organization right from incorporation to liquidation. Political considerations relate to the motives and the action of governments and the way that, via legislation, regulation and the legal /political system, they impact on business.
It is very important that managers understand the role of government in the marketplace, the true impact of the government policy on business and the vast array of legislation impacts on the organizations and their marketing activities.
Business activity is regulated, to a greater or lesser extent, in every country in the world. Government control extends from the way businesses are structured and organized, how enterprises deal with their employees, remunerate and motivate the people and even the degree of profits they make.
Commercial activities are also regulated overtly or covertly, in terms of what we can sell, how we sell and whom we can sell to, in terms of prices we can charge, the distribution channels we can use, the promotion activities we can employ. Very little business and marketing activity is free from the law and acts of government.
Understanding the political environment involves the study of attitudes, philosophies and actions of political parties, government leaders and legislators. Political system existing in the country, roles played by the government and pressure groups are the major factors that affect every enterprise in formulating company strategy.
The strategists must clearly understand the political factors that enable them to predict the most likely future changes in legislation and can plan for them.
2. Economic Forces:
Economic environment is a vital component of the external environment from the standpoint of strategy formulation. The economic considerations refer to the nature and direction of the economy in which a business operates. The success of industry and business depend heavily on economic environment.
Fortunes of industry and business after all, depend on purchasing power of the people and the purchasing power is largely a product of the economic environment. On both national and international levels, a firm must consider general economic conditions, economic conditions of different segments of the population, their disposable income, purchasing power, trends in income distribution, consumption patterns, propensity of people to spend, current income, prices, saving, debt, availability of credit.
Rate of growth of the economy, rate of growth of each sector of the economy, gross domestic product rate of inflation, interest rates, behavior of capital markets, exchange rates, tax rates, prices of materials, prices of energy and the conditions of the labor market are additional economic factors that must be carefully considered in strategic planning.
Gross domestic product refers to the value of a nation’s annual total production of goods and services. Consistent GDP growth generally products a healthy economy fueled by increases in consumer spending. In contrast, GDP decline signals lower consumer spending and decreased demand for goods and services.
High inflation rates have a negative effect on most, but not all businesses. High inflation rates raise cost of doing business, and continued inflation constricts the expansion plans of businesses and triggers government action designed to slow economic growth. Periods of inflation can present opportunities for some firms. For instance, oil companies may benefit during inflationary times of the prices of oil and gas rise faster than the costs of exploration, refinement and transportation.
Short- and long-term interest rates affect the demand for many products and services, especially “high ticket” items whose costs are financed over an extended period of time, such as automobiles, appliances, and even major home renovation or repairs. At the consumer level, short-term low interest rates are particularly beneficial for retailers because they tend to lower rates on credit cards, thereby encouraging consumer spending.
At the corporate level, interest rates also influence strategic decisions related to financing. High interest rates tend to dampen business plans to raise funds to expand or to replace aging facilities. Lower rates, however, are more likely to increase capital expenditures on expansion and development.
The international agreements, the coordinates, economic policies of governments, and international economic conditions influence currency exchange rates. For instance, when such conditions raise the value of the dollar, US firms find themselves at a competitive disadvantage internationally, as the prices of America-made goods rise in foreign markets.
At the same time, American consumers may be inclined to purchase products produced abroad that are less expensive than goods produced domestically. The manufacturers tend to locate more of their plants abroad. Currency exchange rates present challenges because of their domestic and often unpredictable changes over time.
In India the pattern of consumption has shifted from food and other basic items to products and services with high marketing significance. The per capita income continues to be very low. The rate of economic growth for several years continued to be low with an average annual growth of three to 3.5 percent.
Through the last two decades it slightly improved averaging five per cent per annum. After liberalization and globalization of the Indian economy since 1991, the economy has actually started moving on to a higher growth rate. The corporate sector and the capital markets grew substantially during the last decade.
The potential economic impact of international forces has changed the focus of economic environmental forecasting. European Economic Community, OPEC and organization of LDC are the major economic international forces that have influenced the way the business can be done. EEC aimed at the elimination of quotas and establishment of a tariff-free trade for industrial products, which has helped member countries, compete more effectively in international markets.
Following EEC other countries also entered into multilateral trade agreements for international trade that had a profound effect on almost every aspect of business activity in these countries. Countries of Third World and Fourth World have recently started playing a greater role in international business, as a source of opportunities and threats. During the past two decades LDCs have also established and strengthened their trade organizations to demand higher prices and achieve larger real incomes for their members.
Each of these international forces lays an impact for better or worse on the economic well-being of a business. Companies, must therefore, anticipate likely impact of actions taken in both the domestic and international economic areas. Such forecasts are a critical part of the strategic management process.
Probably the most tangible facet of the economic factors is the disposable income of relevant customer base. The future prosperity of any organization will depends on its ability to win and keep customers who are both prepared and able to pay the prices which we need. If our potential customer can’t afford what we provide then we just don’t have a business.
3. Social-Cultural Forces:
Socio-cultural changes have a major impact upon virtually all products, services, markets, and customers. Small, large, profit and not-for-profit organizations in all industries are being challenged by the opportunities and threats arising from changes in social and cultural variables. The socio-cultural aspect of the environment is probably the most difficult to understand, quantify and predict, dealing as it does with people and human behavior.
A business organization can survive in the long run only when it is responsive to the socio-cultural environment of the society in which it operates. The strategists must, therefore, understand the existing environment of the society and visualize potential changes therein before long-range plans are formulated to achieve corporate objective.
The socio-cultural environment is composed of the beliefs, attitudes, values, desires, expectations, degrees of intelligence and education, beliefs and customs, opinions, life styles of people in a society, traditions and social institutions, class structure and social group pressure and dynamics as developed from their cultural, ecological, demographic, religious, educational, and ethnic conditioning.
The values and attitudes of customers and employees can affect strategy. Some of the values and beliefs are much more important to people than others. These values translate into life-style changes that affect the demand for products and services or the way firms relate to employees.
These factors can create threats and opportunities for the firm. Social forces are dynamic with constant change ensuing from individual’s efforts to control and adapt to environmental factors to satisfy their desires and needs.
So strategists must keep up with changes in educational levels and social values in order to assess the potential impact on their strategies. Typical responses of firms to these social factors, however, vary from changes in their strategy or policies to attempt to change social values and attitudes through public relations efforts.
The essence of good marketing is to anticipate and identify what customers want and then be in the right place at the right time to be able to offer it to them. It sounds simple but the anticipation is the difficult part.
The longer the production lead times required for the product or service, the more interest the organization should be showing in trying to unravel the likely future shape of its markets.
4. Technological Forces:
The rate of change of technology has been one of the most visible undercurrents of society of the past twenty years. Technological forces include scientific improvements and innovations that create opportunities or threats for businesses. The rate of technological change varies considerably from one industry to another and can affect a firm’s operations as well as its products and services.
The technological aspect of the environment is concerned with factors like information technology in the use of computers and computerization, with the effect on the cost base of increased IT and automation and with the likely changes that this may have on the types of materials and components that we use, and the general resource base available to the organization.
Changing technology might not only affect the firm’s raw materials, operation and products and services but also can offer major opportunities or threaten the existence of firms. Strategists cannot afford to ignore the technological factors as technology defines the business of their organization.
According to Petrove, there are three implications of technological change; it can affect the relative competitive cost position within a business, it can create new markets and new business segments, and it can collapse or merge previously independent business by reducing or eliminating their segment cost barriers. To avoid obsolescence and promote innovation, a firm must be aware of technological changes that might affect its industry.
The widespread use of the Internet over the past decade is the most pervasive technological force affecting business organizations since the dissemination of the personal computer. The effects are most profound in select industries, such as brokerage houses, where online companies have demonstrated huge gains in the market, or the travel industry where the number of flights, hotels, and travel packages booked over the past decade has skyrocketed.
The Internet has also spawned the advent of online banking, a much less costly means of managing transactions. As such, by 2002, a number of major banks and creditors had begun encouraging customers to pay bills online by offering free software, elimination of fees, and even sweepstakes entries with each transaction. Indeed, the Internet has had a major effect on virtually every industry in the developed world.
The state of technological development varies among different sectors of the industry. The technology used depends on availability of technology, cost of technology, intensity of competition, customer needs and government policy.
New technology may result in the development of entirely new products or new uses of existing products, changes in the processes of production and thus influencing significantly the production line, magnitude of operation, production quality and control and cost structure of business enterprises.
An organization must, therefore, appraise the technological environment while deciding about new investment, modification, removing bottlenecks, by-products and waste control. Any investment decision without consideration of technological factor may spell the quick demise of the organization.
In some cases it is necessary to invest in research and development to improve products so that their life cycle can be extended or replace products near the end of their life cycle. In other cases, environmental scanning is needed to determine what technological change will mean to existing products in terms of their production processes. Technological change can also affect discussion methods, raw materials, or the skills needed by the work force.
The pace of technological change to a great extent depends upon the creativity of people, receptiveness on the part of industry and the availability of venture capital. Government incentives through tax policies, funding and regulations also play a role in technological change.
A willingness to innovate and take risks also seems to be a critical component. Furthermore, technological change requires a receptive, socio-economic climate. Even so, investments in technology, involve other risks. For example, competing technologies may require large investments without assurance that the technology will be accepted. Hence, threat and opportunity from technology also involves other factors.
Not all sectors of the economy are likely to be equally affected by technological change. Some sectors are more volatile than others. There are few good measures of likely volatility. One is the amount spent on research and development. The more an industry spends on R and D, the more likely it is that changes will come.
Strategists in industries affected by volatile technological change must be much more alert to changes than those in more stable industries. However, advance indicators about the nature of change in technology are available there is usually adequate time for strategists to prepare for the impact of change.
5. Demographic Forces:
Corporate planners should also study the demographic environment and identify the broad characteristics of the population that effect the business organization. The growth rate of population, aging pattern, geographical shifts, literacy of population, trends in the educational pattern are major factors in the demographic environment that are relevant to business organizations.
6. Ecological:
Ecology also has entered the mainstream. All types of organization are now faced with issues that they could ignore just a decade ago. Serious environmentalists are still in the minority but those who like to bathe their consumption in a ‘light green wash’ are now the majority.
7. Competitive Forces:
The state of competition needs to be continually monitored for the presence or absence of entry and exit of competitors, substitutes for existing products and services, relative market share of competitors, major strategic initiatives adopted by competitors. The entry of potential competitors will depend on the type and number of barriers to entry.
The barriers to entry may be scarcity of raw materials, economies of scale, product differentiation, access to distribution channels and likely repercussion of established firms. The availability of cheaper substitutes of same or better quality for the firm’s product may pose a threat to its competitive edge.
8. Legal Forces:
Businesses have to operate within the framework of the prevailing legal environment. The strategic planners have to understand the nature and complexity of the whole range of legislations, enactments and legal provisions relating to the conduct of business in general and those connecting to their business in particular.
In recent times, all over the world, legislation regulating businesses has been steadily increasing. India, over the past four or five decades, a great deal of legislation concerning industry and business has been enacted. Despite liberalization some legislations still restrict the freedom of operations of certain industries and business are still required to grapple with a heavy load of legislation relating to business.
Legal environment of business considers the factors including legislation protecting consumer, employee and sectors, corporate affairs, corporate protection, protection of the society as a whole against unbridled business behavior, regulations of products, prices and distribution, controls on trade practices, protecting national firms against the onslaught of foreign firms.
9. International:
An industry and commerce becomes more international in nature so more and more organizations have to deal with an international environment audit. There are, of course, some organizations that are still purely domestic in nature these need go no further than considering the environment of their domestic market.
However, the number of organizations that have no international markets, no international suppliers for various components or raw materials and no international competition in the domestic market are getting fewer and fewer every year.
Enlarging the environment audit then to an international basis for the organization that has overseas markets it will have to consider the political, sociological, technological and economic aspects of each different market in which it intends to operate, paying special attention to the ever present critical social and cultural differences that lie submerged in foreign markets ready to trap the unwary.
Before formulating its strategy for particular international location, a company must evaluate the particular country environment for opportunity and threats, and compare these with its own organizational strengths and weaknesses.
For example, to operate successfully in a global industry such as automobiles, tires, or electronics, a company must be ready to establish a significant present in the three developed areas of the world known as Triad, the term coined by the Japanese management expert, Kenichi Ohmae to refer to the three developed markets of Japan, North America, and Western Europe, which now form a single market with common needs.
Focusing on the Triad is essential for an MNC pursuing success in a global industry because close to 90% of all high- value added, high- technology manufactured goods are produced and consumed in this region.
Ideally a company should have a significant presence in each of these regions so that it can develop, produce, and market its products simultaneously in all these areas. Otherwise, it will lose competitive advantage to Triad-oriented MNCs. No longer can an MNC develop and market a new product in one part of the world before it exports it to other developed countries.