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ECONOMIC ENVIRONMENT OF BUSINESS

INTRODUCTION• Every business organization has to interact and transact with

its environment. • Business environment has a direct relation with the business

organization. • Effectiveness of interaction of an enterprise with its

environment primarily determines the success or failure of a business.

• Identify the environment in which it operates • Formulate its policies in accordance with the forces • Business organization has to tackle its internal and external

environment. • The economic activities are still considerably controlled by the

government.

Concept of business environment

Business environment is the aggregate of all conditions, influences that affect its life

and development.

Business environment consist of all those factors that have a bearing on the business.

Survival and success of any individual depend upon

his capability as to cope with environment

Survival and success of an individual firm depend upon -

Innate strength resources at its command ( Financial and human

resources)

Survival and success of the firm depend on two sets of factors

• Internal factors• External Factors

Business Decision

External Environment

Internal Environment

Business decision

Co. image/brand equity

Human resources

Financial capabilities

Technological capabilities

Marketing capabilities

Macro (General/Remote) Environment

Political/Govt. environment Legal Environment

Micro (Task/Operating) EnvironmentFinanciers

Demographic Environment

Suppliers

Publics

Marketing intermediaries

Customers

Competitors

Global Environment

Social/Cultural environment Technological/Natural environment

Promoters’/shareholders’ values

Mission/Objectivesmanagement Structure

Internal power relationship

Physical assets & facilities

Internal Environment

INTERNAL ENVIRONMENT

Important Internal factors1. Value System

2. Mission and objectives

3. Management Structure and Nature

4. Internal Power Relationship

5. Human Resources

6. Miscellaneous Factors

EXTERNAL ENVIRONMENT

External environment consists of

1. Micro environment

The microenvironment consists of factors in the companies immediate environment that affects the performance of the company.

Factors

1. Suppliers

2. Marketing intermediaries

3. Competitors

4. Customers

5. Public

Macro environment consists of larger societal forces that affect all the factors in the company’s micro-environment

1. Demographic environment

2. Economic environment

3. Political and Government environment

4. Natural environment

5. Physical and Technological environment

6. International environment

7. Socio-cultural environment

Importance of the study of business environment

• To adjust according to the changes takes place in the external environment .

• Development of action plans to deal with technology advancement.

• To adjust to prevailing conditions and influence the environment to make it suitable for the firm.

• To see the impact of the socio-economic changes at the National and International level.

• To analyze the competitors strategy and to formulate counter strategies.

• To help the organization to develop its broad strategies.• To help to prepare the long term policies.

Need of the study of business environment • It is essential for the business firm to keep all the

information about its surrounding environment because – One should care about the environmental changes if

disregard for environmental changes proves very costly.– If the environmental changes are favorable a business

enterprise can expand itself according to changing environment.

– The success of the business enterprise depends on its awareness surrounding environment.

– The business enterprise can become dynamic if she has the knowledge about change in the environment.

Need of the study of business environment

– The business enterprise adjust itself according to the information about changes taking place in the environment .

– If a business enterprise is aware of the fact that environment is getting hostile it individually or along with other business enterprises can make efforts to make the environment hospitable according to the requirement of the business.

Nature of Business Environment• Aggregative: B E is the totality of all the external

forces which influence the working and decision making of enterprises

• Inter Related : Different elements of B E are closely inter – related and inter dependent . A change in one element affects the other elements . Economic environment affects non economic environment which in turns affect the economic conditions. Ex economic liberalization in India since 1991has opened up new opportunities for private sector and foreign entrepreneurs . Social pressures against pollution led enactment of anti pollution act.

• Relative : Business environment is a relative concept . It differs from country to country and even region to region. Capitalist economies like those of US A have a different kind of environment than communist economies . The economic system in a country affects the business environment.

• Inter-Temporal: B.E. is also an inter-temporal concept as it change over time. For business environment in India today is much different from that prevailing before 1991. In short run business environment may remain static .But in long run ,it does change.

• Uncertain : B.E.is largely uncertain because it is very difficult to forecast the future environment . When environment is volatile ,i.e. .changes very fast , uncertainty increases .

• Contextual : B.E. provides the macro frame work within which the business firm (micro unit)operates. The environmental forces are those given within which an individual enterprises and its management must function.

B.E. exercises tremendous influence on working environment. The change taking place in environment must be continuously monitored to judge on business . Appropriate and timely steps must be taken to face E .changes

Coping with environmental changes

1. Buffering : Buffering techniques are used to soften the impact of environment on the organization. Stocking materials , Preventive maintenance , employee training . These precautionary measures enable the organization to avoid damage due to changes in environment .

• Levelling : Whereas buffering absorbs environmental fluctuations , levelling or smoothing attempts to reduces fluctuations in environment . E.g. retail firms faced seasonal fluctuations offers price cuts in order to spread sales more evenly throughout the year . Special air fares for night flights is another example of levelling .

• Anticipation: It means acquiring information about probable changes in the environment . Manufacturing firm tries to anticipate demand for its product before deciding production schedule and related matters. Other areas in which firm can anticipated changes are customer needs , competition , technology and availability of human resource

• Rationing: Allocation of organizational resource according to a system of priorities . Rationing is resorted to when an org. is unable to meet all demand. E.g demand exceed supplies

• Dominating: The organization attempts to control event in the environment and reduces its dependencies on them.

• Changing: an organization may change itself ,its operations and output. May change product line as per changing preferences of customer.

• It is difficult changing strategy

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ENVIRONMENTAL SCANNING (ANALYSIS)

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CONCEPT OF ENVIRONMENTEnvironment literally means surroundings which influence the body or organization.The environment of any organization is the aggregate of all conditions, events and influences that surround and affect it.Since the environment influences an organization in many ways, its understanding is of crucial importance.

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Characteristics of Environment

Environment is complexEnvironment is dynamicEnvironment is multifacetedEnvironment has a far-reaching impact.Since the environment is complex, dynamic, multi-faceted and has a far reaching impact, dividing it into external and internal components enables us to understand it better.

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Meaning of environmental Scanning

Environmental analysis ( scanning ) is the process by which corporate planners monitor the economic, governmental, supplier, technological and market environment to determine the opportunities and threats to their enterprise.

The fortunes of organizations is determined by changes in social, economic, political, business and industrial conditions.

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Influence of environmentOpportunityThreatStrengthWeakness

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Approaches to Environmental Scanning

Systematic approach

Formats for various issues are developed and scanning is done systematically in a step by step Faison.

Process Information Approach

Information is available from trade papers, trade magazines, internet and such data is summarized and used in strategic management

Ad Hoc ApproachAd Hoc ApproachSpecific information on selected environmental Specific information on selected environmental factors is collected by conducting special studiesfactors is collected by conducting special studies

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Need /Importance/Benefit of Environmental Analysis

Technological forecasting indicative of future opportunities and challengesRisk IdentificationStrategic PlanningOpportunities forecastingEnvironmental –organization linkage identification

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Role of environmental Scanning in Organizations

Function-Oriented RoleTo improve organizational performance by providing environmental information concerning effective performance of specific organizational functions

Integrated Strategic Planning RoleTo make top mangement aware of the issues that arise in the firm’s environment and having a impact on planning.

Policy Oriented RoleTo make top management informed about major trends emerging in the environment

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Sources of information for environmental scanning

Documentary or secondary sources of informationMass MediaInternal SourcesExternal agenciesFormal StudiesSpying and surveillance

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Factors affecting environmental appraisal

Strategy-related factorsAge of the organizationSize and power of the organizationGeographic dimension of the

organizationType of businessInfluence of business organizationVolatility of environmentManagerial caliber

Environmental Scanning & MonitoringTechniques

Environmental Scanning & Monitoring

Environmental scanning is a concept from business management by which businesses gather information from the environment, to better achieve a sustainable competitive advantage.

To sustain competitive advantage the company must also respond to the information gathered from environmental scanning by altering its strategies and plans when the need arises.

Environmental Scanning & Monitoring- Techniques

SWOT

Industry Analysis

Techniques

Competitor Analysis

PEST ETOP

SWOT(Strength-Weakness-Opportunity-Threat)

Identification of threats and Opportunities in the environment (External) and strengths and Weaknesses of the firm (Internal) is the cornerstone of business policy formulation; it is these factors which determine the course of action to ensure the survival and growth of the firm.

SWOT Analysis

• The SWOT analysis is an extremely useful tool for understanding and decision-making for all sorts of situations in business and organizations. SWOT is an acronym for Strengths, Weaknesses, Opportunities, Threats.

• SWOT analysis came from the research conducted at Stanford Research Institute from 1960-1970. The background to SWOT stemmed from the need to find out why corporate planning failed. The research was funded by the fortune 500 companies to find out what could be done about this failure. The Research Team were Marion Dosher, Dr Otis Benepe, Albert Humphrey, Robert Stewart, Birger Lie.

SWOT: Studying Internal & External Environment

The aim of any SWOT analysis is to identify the key internal and external factors that are important to achieving the objective. SWOT analysis groups key pieces of information into two main categories:

– Internal factors – The strengths and weaknesses internal to the organization.

–External factors – The opportunities and threats presented by the external environment.

Examples of SWOTs

• Strengths and Weaknesses– Resources: financial, intellectual, location – Cost advantages from proprietary know-how – Creativity / ability to develop new products – Valuable intangible assets: intellectual capital – Competitive capabilities – Big campus selection

• Opportunities and Threats– Takeovers – Market Trends – Economic condition – Mergers – Joint ventures – Strategic alliances – Expectations of stakeholders – Technology – Public expectations – Competitors and competitive actions – Poor Public Relations Development – Criticism (Editorial) – Global Markets – Environmental conditions

Uses of SWOT Analysis

• Corporate planning

• Set objectives – defining what the organization is intending to do

• Environmental scanning – Internal appraisals of the organizations SWOT, this needs to include an

assessment of the present situation as well as a portfolio of products/services and an analysis of the product/service life cycle

Analysis of existing strategies, this should determine relevance from the results of an internal/external appraisal. This may include gap analysis (compare its actual performance with its potential performance which will look at environmental factors)

Strategic Issues defined – key factors in the development of a corporate plan which needs to be addressed by the organisation

Develop new/revised strategies – revised analysis of strategic issues may mean the objectives need to change

• Establish critical success factors – the achievement of objectives and strategy implementation

• Preparation of operational, resource, projects plans for strategy implementation

• Monitoring results – mapping against plans, taking corrective action which may mean amending objectives/strategies.

Also;

Use SWOT analysis for business planning, strategic planning, competitor evaluation, marketing, business and product development and research reports.

PEST Analysis

A scan of the external macro-environment in which the firm operates can be expressed in terms of the following factors:

•Political•Economic•Social•Technological

The acronym PEST (or sometimes rearranged as "STEP") is used to describe a framework for the analysis of these macro environmental factors. A PEST analysis fits into an overall environmental scan as shown in the following diagram:

Environmental Scan

/ \

External Analysis Internal Analysis

/ \

Macroenvironment

Microenvironment

|

P.E.S.T.

Political Factors

Political factors include government regulations and legal issues and define both formal and informal rules under which the firm must operate. Some examples include:•tax policy•employment laws•environmental regulations•trade restrictions and tariffs•political stability

Economic Factors

Economic factors affect the purchasing power of potential customers and the firm's cost of capital. The following are examples of factors in the macro economy:

•economic growth:•interest rates :•exchange rates :•inflation rate:

Social Factors

Social factors include the demographic and cultural aspects of the external macro-environment. These factors affect customer needs and the size of potential markets. Some social factors include:•health consciousness•population growth rate•age distribution•career attitudes•emphasis on safety

Technological Factors

Technological factors can lower barriers to entry, reduce minimum efficient production levels, and influence outsourcing decisions. Some technological factors include:•R&D activity•automation•technology incentives•rate of technological change

Industry Analysis

• An industry is a group of firms producing a similar product or service

• An examination of the important stakeholders’ group in a particular corporation’s task environment is a part of industry analysis

Porter’s approach to Industry Analysis

• A corporation is most concerned with the intensity of competition within its industry

• The level of this intensity is determined by basic competitive forces

• In scanning its industry, the corporation must assess the importance to its success of each of the six forces

Forces Driving Industry Competition

Threat of New Entrants

Bargaining Power of Suppliers

Bargaining Power of Buyers

Relative Power of Unions, Governments, etc.

Potential Entrants

Threat of Substitute Products or Services

Industry Competitors

Rivalry Among Existing Firms

Other StakeholdersBuyers

Substitutes

Suppliers

Threat of New Entrants:Some Barriers to Entry

• Economies of Scale• Product Differentiation• Capital Requirements• Switching Costs• Access to Distribution Channels• Cost Disadvantages Independent of Size• Government Policy

Properties of Entry Barriers

• Entry barriers can and do change as the conditions change

• Entry barriers can change for reasons inside the firm : impact of the firm’s strategic decisions

• Some firms may possess resources or skills which allow them to overcome entry barriers into an industry more cheaply than most other firms

Rivalry Among Existing FirmsIntense Rivalry is Related To:

• Number of Competitors: numerous or equally balanced competitors

• Rate of Industry Growth: slow industry growth• Product or Service Characteristics: Lack of

differentiation or switching costs• Amount of Fixed Costs : high fixed or storage costs

• High fixed or storage costs• Lack of differentiation or switching costs• Capacity augmented in large increments (leading to

overcapacity and price cuttings)• Diverse competitors• High strategic stakes• High exit barriers (specialized assets, fixed costs of

exit, strategic interrelationships, emotional barriers, government and social restrictions)

Shifting Rivalry

• The factors that determine the intensity of competitive rivalry can and do change

• As an industry matures, its growth rate declines, resulting in intensified rivalry, declining profits

• An acquisition can introduce a different personality to an industry

• Focusing selling efforts on the fastest growing segments can reduce the impact of industry rivalry

Entry Barriers and Exit Barriers• When entry barriers are high and exit barriers are

low, entry will be deterred, and unsuccessful competitors will leave the industry

• When both entry and exit barriers are high, profit potential is high, but is usually accompanied by more risks, and unsuccessful firms will fight to stay

• The worst case is when entry barriers are low and exit barriers are high (overcapacity, poor profitability)

Pressure from Substitute Products

• Substitutes limit the potential return of an industry by placing a ceiling on the prices firms in the industry can profitably charge

• Identifying substitute is searching for other products that can perform the same function as the product of the industry

• The impact of substitutes can be summarized as the industry’s overall elasticity of demand

Bargaining Power of Buyers

• Buyers compete by forcing down prices, bargaining for higher quality or more services, and playing competitors against each other

• A buyer’s group is powerful if:1. It purchases large volumes relative to seller sales2. The products it purchases from the industry

represent a significant fraction of the buyer’s cost of purchase (shop for good price)

3. The products it purchases from the industry are standard or undifferentiated

4. It faces few switching costs5. It earns low profits (thus sensitive to costs)6. Buyers pose a credible threat of backward

integration7. The industry’s product is unimportant to the quality

of the buyer’s products or services8. The buyer has full information

Bargaining Power of Suppliers• Suppliers can exert bargaining power over participants in

an industry by threatening to raise prices or reduce the quality of purchased goods and services

• A supplier group is powerful if:1. It is dominated by a few companies2. It is not obliged to contend with other substitute products for

sale to the industry3. The industry is not an important customer4. The supplier’s product is an important input to the buyer’s

business

5. The supplier’s group products are differentiated or it has built up switching costs

6. The supplier group poses a credible threat of forward integration

7. Labor must be considered as a supplier that exerts great power in many industries

Government as a force in industry competition

• Government role as supplier and buyer can be influenced by political factors

• Government regulations can set limits on the behavior of firms as suppliers or buyers

• Government can affect the position of an industry with substitutes through regulations, subsidies, or other means

• Government can affect rivalry among competitors by influencing industry growth

Stages of Environmental Analysis 1. Environmental Scanning : Scanning means the process

of analyzing the environment for identifying the factors which may influence the business . Its purpose is to identify the emerging trends or early warning signals . Such trends may have evolved over time or may appeared suddenly . E.S. alters the organization to potentially significant forces in E E so that suitable strategic initiative can be taken before these forces become critical for the organization. Scanning is basically exploratory in nature . There are so many E.F. which influences the operation of a business .All These factors may not be relevant . Therefore critical and high priority factors must be identified .

2. Environmental Monitoring : At this stage information from the relevant environment is collected. Monitoring is a follow up and deeper analysis of relevant environmental forces identified through scanning . Several techniques are used to collect the relevant facts about environmental factors . i.e. company records , publications , spying and verbal talks with employees , customer dealers ,suppliers and competitors are the main sources of data.

3. Environmental Forecasting : Forecasting is the process of estimating the relevant events of future based on the analysis of their past and present behaviour . It is necessary to anticipate future events before any strategic plans are formulated . Forecasting can focus on future aspects of environment which affects the organization . Forecasts are made for economic , social, political and technological element of environment . Several techniques like –Time series analysis, Delphi method ,etc are used for the purpose of forecasting .

4.Diagnosis (Assessment) : Environmental factors are assessed in terms of their impact on the organization.

ECONOMIC SYSTEMSThere is a great connection between

political ideology and economic systems

TYPES OF ECONOMIC SYSTEMS

TYPES OF ECONOMY

On the basis of

ownership of means of production

On the basis of levelOf

development

CAPITALISM DEVELOPEDCOUNTRIESSOCIALISM MIXED

ECONOMYDEVELOPING COUNTRIES

CAPITALIST ECONOMY

In a capitalist economy, households and firms are the basic production units.Also known as free enterprise economy and market economyCharacterised by private ownership of the means of production, individual decision making and use of the market mechanism to carry out the decision of individual participants and facilitate the flow of goods and services in markets.

TYPES OF CAPITALISM1. Laissez-faire capitalism2. Regulated capitalism

• Characteristics of Capitalism– Free Enterprise– Private ownership– Limited Role of Government– Absence of a Central Plan– Consumer’s Sovereignty– Competetion– Freedom to Save and Invest– Freedom of Choice of Occupation– The Market System

CapitalismMERITS

• Enterpreneurs get an incentive to search for better ways of serving consumer needs.

• Constant improvement in products and processes

DEMERITS

• Insufficient investment in low profit areas.

• Resource allocation not optimal• Leads to concentration of income

and wealth• Unemployment• Monopolistic growth

SOCIALIST ECONOMY• Means of production are either

owned or controlled by the state and the resource allocation, investment pattern, consumption, income distribution etc are directed and regulated by the state.

• There are two types of socialist economy– Socialist command economyThere is no individual freedom of

choice of consumption and employment.

– Market socialismDecisions regarding allocation of

resources are made both collectively and individually

SOCIALIST ECONOMY contd

• In a socialist state there is no place for private property and private enterprise.

• The entire national income is distributed as wages among the workers.

• Found in communist countries.• Collective goal was given priority over individual

goals.

SOCIALIST ECONOMY contd

• While the objective of a socialist economy is to mobilize economic resources for the public good, the opposite seems to have occurred. State owned enterprises have little incentive to control costs and be efficient, because they cannot go out of business.

• Dynamism and innovation are absent.• Stagnation : A period of little or no growth in the

economy. Economic growth of less than 2-3% is considered stagnation

Characteristics of Socialism

– Government ownership– Distribution of income– Restriction of occupation– Central Authority– Restriction of consumption– Social welfare– Peaceful and Democratic evaluation

SocialismMERITS

• Less exploitation• Price Control• Social welfare• Class less society• Importance of labour• Regulation of government over

property and means of production

DEMERITS

• Too much government intervention.

• Job security leads to inefficiency • Talents not fully utilized• No consumer sovereignty• Central planning need not be

always right

MIXED ECONOMY

Mixed economy is characterised by the co-existence of public and private sectors.In a mixed economy certain sectors of the economy are left to private ownership and free market mechanisms while other sectors have significant state ownership and government planning.

MIXED ECONOMY contd

• The primary difference between the mixed economy and market socialism is the relatively greater importance of individual decision making , private property and the reliance on market determined prices, to guide the allocation of resouces.

MIXED ECONOMY contd

• In mixed economy, government tend to take into state ownership troubled firms whose continued operation is thought to be vital to national interests.

• India has a mixed economy.

CHARACTERISTICS OF MIXED ECONOMY

• Public Sector• Private ownership of the means of production

and profit induced commodity production.• Decisive role of market mechansim

MERITS OF MIXED ECONOMY

• Mixed economy framework is a feasible proposition for a developing country as it allows for at least a modest rate of growth, which is both steady and less subject to fluctuations in economic activity at the international level.

DEMERITS OF MIXED ECONOMY

Concentration of economic power. Built in tendency to slide back Bureaucratic inefficiency and corruption Less firm framework of the mixed economy Denial of social justice.

Capitalism, Socialism and Communism Compared

Characteristics Capitalism Socialism Communism

1 2 3 4Economic Market

Freedom to compete with the right to invest

Limited competition withState-owned industries.

Absence of Competition withState-owned markets and industries.

Individual Incentives

Profits and wages in relationto one's ability and willingnessto work

Profits recognised. Wagesfairly in relation to efforts.

Profits not allowed. Workers urged to work for the glory ofthe State.

Capital Sources

Capital invested by ownerswho may also borrow on credit. Capital may be reinvested fromprofits. Depreciation is legal.

Obtained from owners and fromstate-issued bonds for State-ownedindustrie.

State provides all resources to start business owned by the State. No depreciation.

Capitalism, Socialism and Communism Compared Characteristics Capitalism Socialism Communism

1 2 3 4

Labour Workers are free to selectan employer and an occupation

Workers allowed to selectoccupation. State Planningencourages employment.

The State determines one's employer and employment.

Management Managers are selected onbasis of ability. Managers have freedom to make decisions

Managers in State-ownedindustries are answerable to the State. Non-monetary rewards emphasised.

Key managers must be party members. Absence of freedomto make decisions.

Business Ownership

Individuals have the right to own a business and to contractwith others.

State owns the basic industries. Other businessmay exist.

State owned all productive capacity including communes.

Risk Assumption

Losses assumed by owners. May transfer business risks to other businesses through insurance.

People assume risks of State-owned industries. Losses taken from taxes.

Economic production ownedby the State. Risks assumed bythe State. Losses reduce

standard of living.

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