Every business is part of an external network called the Environment. This network plays a large role in the way a business functions and is run. The effects of the environment on the business can be both a boon or a bane to the business.
The External Environment in which a business operates can be categorically divided into various factors. A few that will be discussed here are :
* Competition in the Market
* Economic Environment
* Political Environment
* Population (Sociological Environment)
* Ecological Environment
* Technological Environment
All these factors compose the External Environment. Every business needs to take all these factors into account when carrying out its operations because each one in its own way has a very real impact on the success of a business. However some businesses carry out the less comprehensive but still valuable PEST (Political, Economic, Sociological and Technological Environment) Analysis.
Competition in the Market:
On setting up and throughout the course of its existence, a business does constant research on the Market Structure of the market it operates within. This is the amount of competition that exists in a market. This is what determines the prices of the business’ goods or services.
There are a number of standardized ‘Models of Competition.’ These models are calculated taking into account various sub-factors such as ease with which a business can set-up and leave the industry, consumer knowledge about products, number of firms, and the ability of a firm to fix prices on its goods or services. A few models are :
1. Perfect Competition – Firms produce identical products;Consumers have perfect knowledge;No barriers to setup or leave industry;Each business can’t fix prices on products (Price Takers) (ex: Pens market)
2. Monopoly – Of 2 types: Legal and Pure. Legal means the firm controls >25% of the market. Pure means the firm has 100% control of the market. Difficult for other firms to enter market;Monopolists can fix prices easily (Price Makers) (ex: US Postal Service)
3. Monopolistic Competition – Large number of smaller firms control market;Very few barriers to entry;Brand identity plays big role;Limited Price Making. (ex: CK, Hilfiger, Levi’s)
4. Oligopoly – Market dominance by few firms;Brand Identity;Some Price Making or Collusion;Barriers on Entry. (ex: Nokia, Pepsi)
The function of a country’s (and world’s) economy affects the running of a business. An expanding economy means more money and more demand for a business’ products. A receding economy generally means less demand for a business’ products. However, for producers of inferior goods or services (Potatoes, Public Transport,etc), recessions provide an increase in demand. The way an economy operates is also sometimes intertwined with a government’s objectives.
Unemployment is very important for a business. If unemployment is very low, the labour market is ‘tight’ as few people have to fill in many posts and may have to raise wages. The supply of skilled labour is also not good. High unemployment on the other hand means that there is a much larger labour pool waiting to be tapped, so wages can be kept low. However, if the product is a luxury then demand will also definitely fall.
Inflation is a persistent rise in the general price level. Businesses have to watch out for this as this leads to them having to incur increased costs (Shoe-Leather Costs, Menu Costs and Tax Distortions), reduced purchasing power and increased borrowing. This means their profit margins start decreasing. This may also lead to greater wage demands from employees to keep up their previous standard of living. This proved to be a great problem in countries like Crotia (1150% in 1993) and Tajikistan (1500% in 1995).
The Business Cycle is a useful way of showing a country’s economic ‘ups and downs’. This measures the changes in the Gross National Product (GNP – Refer Appendix 1). It reflects the general trends of Injection (addition) or Withdrawals of capital into and from the economy. Businesses have to watch out for trends such as very fast growth or large recession as this affects inflation and the prices of their products.
Governments are likely to manage their economies to achieve a certain set of objectives. These objectives (in this order) include :
1. Keeping Inflation Low
2. Keeping Unemployment Low
3. High Economic Growth
4. Equilibrium of Balance of Payments
To attain these aims, governments have a set of policies. These generally include:
This policy uses government spending and taxation to manage the level of aggregate demand in the economy. If the economy needs a boost, government expenditure can be raised. This creates employment, increased income and demand for other goods. Taxes can also be decreased to encourage consumers to spend more money. Expenditure can also be curbed if the economy needs to slow down to control inflation. Also, an increase in income tax stops people from spending as much.
This is the manipulation of interest rates and the money supply to influence the economy. Governments can increase or decrease interest rates to control the money supply to regulate the amount of borrowing by businesses. They can restrict bank loans too by instructing banks to hold onto more money.
Supply Side Policies:
These are aimed at improving the potential of the economy to produce. They may include policies to improve workforce and business efficiency. These include anti-inflationary policies, policies that increase demand, trade and exchange rate policies.
However, sometimes various policies conflict each other. For instance higher interest rates control inflation but also spur unemployment. Also economic growth policies generally conflict with anti-inflationary policies. Maximum output is generally at the cost of ecological resources. In such cases, both governments and various businesses must try to come up with an optimum solution. Also interesting to read about fiscal policy questions and answers
Population (Sociological Population):
Statistics about the population of the region (city, country, etc) in which a business operates is vital for optimum outputs . Every developed business looks at these statistics regularly to spot trends and if needed, act on these trends to maximize outputs.
Size – A greater population means more demand and potential sales of a firm’s goods. It also means a greater labour pool.
Migration – Immigration means the influx of people into a certain part of the world. From a business’ standpoint, it means a greater market for people of a certain age, or from a certain country. For example, an influx of Chinese people in cities across the world is responsible for each ‘China Town’. There is a much greater scope to sell Chinese products in China Towns than in other parts of a city.
Emigration means that a certain amount of the previous population has now left the area and gone somewhere else. This could mean a market lost.
Mortality – This is the number of living babies born per 1000 living people. A rise would mean a greater market for baby products. A decline would mean dearth of potential future employees.
Natality – This is the number of people who die per 1000 living people. A rise might mean a greater market for products pertaining to the ageing population and that the Dependency Ratio has increased.
Geographical Distribution – The distribution of people in different parts of the world reflect not only the potential markets a business might enjoy but also the labour pool. A more urban crowd would react to multiplexes more favourably than a rural one.
Gender Distribution – An increasing female workforce means more income and thus more demand for ‘working woman’ products. Also, a consequence of more working women is that kids are borne later in life – demand for some products may fall temporarily.
Children – ‘Pester Power’ is very influential. This is the power of kids to irritate their parents into buying them products. Firms have reacted by creating flashy, attractive packaging for their products in order to appeal to kids’ senses.
Thus various details about the population in an area are required by businesses to enhance their sales.
Along with producing goods, many firms end up damaging our ecological environment. They have caused Air, Water, Soil and other types of pollution.
– Factories’ emissions, use of CFCs and other harmful gases contribute to Air Pollution. Industries are a major culprit in the Global Warming and problems.
– Industries like breweries, mills and chemical manufacturers contribute to water pollution, especially by dumping their waste conveniently into water bodies. These discharges are major health concerns.
– Soil Pollution is caused mainly by chemical manufacturers and agro-based industries (textile, paper, etc) because of the seepage of harmful substances into the ground, and then into water supplies.
– Noise Pollution, a milder form of pollution is caused due to either machines or even customers at the local store. They have an adverse effect on humans.
This is where the Government comes in. Most (or all) governments in the world have passed legislation that restricts industry from creating pollution. If violated, the firms have to pay a penalty, generally heavy. Examples are the Clean Air Act and the Environmental Protection Act. Pressure groups make sure that these laws are adhered to and also lobby for more stringent laws to be passes all the time.
To cope with this recent development, businesses resort to eco-friendly practices such as usage of cleaner, renewable fuel sources, tree-planting, safe waste disposal methods, etc. To extract a benefit from these practices, businesses take full initiative to advertise their “clean” nature. This has a dual – benefit. Not only are customers attracted to their products, this also makes other businesses look bad and forces them to resort to the same practices at their cost. This bad advertisement can put a firm into a tough spot (ex: Coke and Pepsi with the pesticide issue).
The advent of technology has created a revolution in industry. It has obliterated the use of redundant labour, of inefficient, inaccurate methods and replaced them with machines that do the job faster and better.
Technology can be used in 4 main functions of the business:
Marketing – Global promotion of a firm can now be ensured via the Internet which is probably the biggest revolution industry has ever seen. Visual techniques of marketing can be enticing and innovative, creating a brand identity through the ad. We wouldn’t have a TV, radio or computer to advertise through without technology. Distribution is also much easier now. We can order online anywhere in the world and know that the order has been received. For companies like DHL and FedEx, this is the very basis of their existence.
Production – Automation of various stages in production, from extraction of raw material to final processing has increased efficiency manifold in industry. Robots and other machines now perform what humans used to do faster, more accurately and more cost-effectively. This is also much safer for people. However, jobs are made redundant and causes unemployment to rise. Computer Aided Design (CAD) is also at the cutting edge of production and is responsible for computers getting smaller and faster, which in turn helps businesses.
Human Resources – Communication has improved greatly with e-mail and mobile phones, for example. This improves interaction both within and between firms. Also, transport is faster with jet aircraft. This has had a tremendous effect on sales and productivity. Recruitment is made much easier through the reaches of the Net.