Why is it important for a firm to study and understand the external environment?

Published in Journal

Year: Jan, 2018
Volume: 14 / Issue: 2
Pages: 471 - 475 (5)
Publisher: Ignited Minds Journals
Source:
E-ISSN: 2230-7540
DOI:
Published URL: http://ignited.in/a/57613
Published On: Jan, 2018

The external environment of a business, also known as the macro environment, includes all factors outside the reach of the business, that can impact the operations of the business. External factors influence the choices a business makes, as they determine opportunities and risks. Let's take a look at these different factors in more detail.

External business environment

All businesses are impacted by their external environment. Sometimes a business has to act upon and react to what happens outside of the scope of its operations. These external influences are known as external factors. Multiple different factors can influence a business's external environment. These factors are often unpredictable and can change suddenly.

The external environment plays a huge role in the types of strategies and actions a business decides to implement. The external environment can affect competitiveness, budgeting, decision making, and the marketing mix.

The main external factor that influences business most is competition.

Competition is the degree to which businesses compete with one another in the market.

Most businesses, especially when operating in a popular industry, will have to face intense competition. The amount and type of competition mostly depend on the industry a business operates in. Although competition is one of the most significant factors, several other external aspects affect the strategies and actions taken by a business.

External environmental factors

Four main components make up the external environment of businesses. These are the main external factors you have to consider when operating a business.

Economic factors

Several economic factors can influence the business environment. One of them is market conditions. Size and growth rates are good indicators of market conditions. Market conditions are made up of many different economic elements that affect the attractiveness of a market. For instance, good market conditions can be described by economic growth and increasing market demand. Economic growth measures the value of output in a country's economy. One way you can measure economic growth is through Gross Domestic Product (GDP). This is the total value of all finished goods and services produced in a country's economy during a given period. Another factor is market demand, which measures how much of a good or service consumers are willing and able to pay for.

Demographic factors

Demographic factors are related to the population. For instance, an increase in the size of a population will most likely lead to an increase in demand for goods and services, as there are more potential consumers. Changes in the age of a population will also have significant influences on businesses.

An ageing population (more old people) will have different demands than a younger population. Older consumers tend to want and need different goods and services than young people.

Environmental and social factors

Society increasingly expects higher standards of environmental and sustainability-related awareness from businesses. Unfortunately, a lot of businesses contribute significantly to the creation of environmental damage.

Some governments have stepped up in this regard, passing certain legislation in order to protect the environment. Many governments impose quotas on the amount of harmful substances firms can emit within a timeframe, and fine businesses that over-pollute or ignore the legislation. These legislations are there to force firms to take into account the social costs (the cost to society and the environment) of production.

External environment analysis

A useful tool for analysing the external environment of an organisation is 'PESTLE'. PESTLE analysis takes a look at six different external factors that could have an impact on your business and rates the intensity and importance of each. PESTLE stands for political, economic, social, technological, legal, and environmental/ethical factors.

Political

The 'P' in PESTLE. Political factors play a huge role for businesses operating in certain industries. Political factors include:

• Political stability

• Government stability

• Industry regulations

• Competition policy

• Trade union power

Economic

The first 'E' in PESTLE. As outlined earlier, economic and market factors can significantly impact business functions. Some economic factors to consider include:

• Interest rates

• Inflation rates

• Unemployment

• GDP and GNP trends

• Investment levels

• Exchange rates

• Consumer spending and income

Social

The 'S' in PESTLE. These socio-cultural factors include:

• Demographics

• Lifestyles and lifestyle changes

• Education levels

• Attitudes

• Level of consumerism (how important consumption of goods and services is to people of a certain demographic)

Technological

The 'T' in PESTLE. Technology, especially in today's society, plays a huge role in business development and decisions. With technology developing rapidly, here are a few factors to keep in mind when considering the external environment of the business:

• Levels of government and industrial R&D investment

• Disruptive technologies

• New production processes

• Big data & AI

• Speed of technology transfer

• Product life cycles

Legal

The 'L' in PESTLE stands for legal considerations regarding the external environment of a business. These include:

• Trade policies

• Legislative structures

• Employment legislation

• Foreign trade regulations

• Health and safety law

Environmental/ethical

Finally, the second 'E' stands for environmental and ethical factors. These include:

• Sustainability laws

• Tax practices

• Ethical sourcing

• Energy supply

• Green issues

• Carbon emissions and pollution

External Environment - Key takeaways

• All businesses are impacted by their external environment. Sometimes a business has to act upon and react to what happens outside of the scope of its operations.
• The external environment, also known as the macro environment, is out of the control of an individual business.
• Factors like competition, market, economic, demographic, and environmental factors all play a role in the external environment of an organisation.
• Market factors are measured based on market conditions and demand, or the size and growth of the market.
• Economic factors include interest rates and income levels of the population.
• Demographic factors are related to the size and age of the population.
• Environmental factors are related to levels of emissions and the social responsibility of firms.
• An effective tool for analysing the external environment is a PESTLE analysis.
• PESTLE evaluates political, economic, social, technological, legal, and environmental and ethical factors.

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