Download External Environment (Unit 1.5)

External Environment (Unit 1.5)
Ambar Deleon
Period 5
Internal Factors
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Definition: the constraints and opportunities within a firm’s own control.
These limitations are usually dominated by the rules, policies and culture
of the business. Examples of internal constraints include:
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4.
Finance: Most firms lack sufficient sources of finance. Firms can either
seek additional sources of finance or use alternative ways to achieve
their objectives.
People: Poor working relations harms a firms ability to achieve their
goals. Motivational strategies can help towards improving conflicts in
the workplace.
Marketing: Their marketing campaigns are not as attractive as their
rivals, such as interior products, packaging, customer service and
promotions.
Production: Techniques and stock control systems may be improved to
enhance its overall efficiency and competiveness.
External Factors are those issues which either restrict or aid the
performance of a business but are beyond its control.
PEST Analysis
PEST is an acronym for the Political, Economic, Social and Technological
opportunities and threats of the external environment.
 Political
o Government legislation ( such as employment law, consumer protection
rights, copyright and trademark regulations) defines the boundaries in which
business can operate.
o The political and economic stability of a country can be affected by taxation
and interest rate policies.
 Economic
o The state of the economy in which business operate is determine by four key
variables: inflation, unemployment, economic growth and international trade.
 Social
o Social, cultural and demographic changes can also present opportunities or
threats to a business
 Technological
o Business efficiency are being improved by the advances in technology and
work process.
Threats and Opportunities
 Threats: External factors that can harm a business.
o Examples: Economic recession, oil crisis or high inflation.
 Opportunities: external factors that can improve a business
o Examples: lower taxes and interest rates
 Variations of the PEST analysis are:
 PESTLE: The last two letters stand for the external Legal and
Environmental opportunities and threats.
 STEEPLE: The third E stands for Ethical opportunities and threats.
3 Steps to a PEST analysis
 Brainstorm: What will most likely affect the business?’
o External factors under each of the PEST headings.
 Discuss: Which factors will have the most significant impact on the
business?
o This step involves devoting time and resources to research these
factors and gather relevant information to weigh the importance
of the different factors.
 Summarize: What to do with the business? Strategies?
Advantages & Disadvantages
 The PEST analysis is useful for identifying advantages and disadvantages
of a decision.
o Example: If the overall opportunities outweigh threats, the business
should pursue the option.
 However, in reality, some external factors are subject to rapid and
unforeseeable changes.
 One key advantage id using a PEST analysis is that it is simple to use.
o Example: Helps managers to be thorough and logical in their analysis
of the external opportunities and threat.
Social and Cultural Opportunities
and Threats
 The attitude of society towards a variety of issues will affect what goods
and/or services are introduce are provided in the economy.
 Demographic changes can also present opportunities and threats to
businesses.
o In developed nations, demographic changes have affected recruitment
practice, marketing strategies and the products provided by businesses.
 The changing attitudes towards the role of women have had profound impacts
on businesses.
 The acceptance and awareness of multiculturalism leads to more business
opportunities.
Technological Opportunities and
Threats
 Technology has deeply affected all aspects of business functions:
 HR: Recruitment process
 Marketing: E-commerce
 Finance: annual reports published online
 Operations Management: benchmark data
 The internet can provide opportunities:
 Easier access to information,
 Less language and cultural barriers
 Costs of production are reduced.
 Potential threats:
 Price transparency (customers can compare prices without leaving home)
 Online crime
 Higher costs of having to train employees in being tech-competent.
Important Factors about Technology
 Apart from the internet, technology can also offer other opportunities to
businesses such as:
 New working practices
 Example: Using video conferences to cut the cost of face-to-face
meetings and international recruitment.
• Increased productivity and efficiency gains.
• Example: Robots and machine are faster, accurate and can work longer
hours, thus quicker product development time.
• The creation of jobs
• Examples: increased need for maintenance and technical support
 Technological threats:
• Is not always reliable or secure.
• It can be costly.
• Automation has led to decrease in jobs in primary and secondary sector
industries.
Economic Opportunities and Threats
 The economic environment refers to the large-scale economic factors affecting
the economy as a whole.
 Governments strive to achieve four fundamental macroeconomic objectives:
 Controlled inflation
 Economic growth
 Reduced unemployment
 Acceptable International trade balance
 Government macroeconomic policies are used to achieve these four goals and
will have either a direct of indirect effect on business activities.
Controlled Rate of Inflation
 Infliction can be defined as the continual rise in the general level of prices in the
economy.
 The two main causes of inflation are:
 Demand Pull inflation
o Excessive aggregate demand in the economy.
o Any factor that causes a rise in consumption, investment,
government spending or international trade earnings will lead to the
increase in the economy’s aggregate demand.
 Cost push inflation
o Higher costs of production leading to a rise in prices so the firms can
maintain their profit margins.
o Examples: Soaring raw material prices caused by an oil crisis or
higher rents demanded by landlord.
The Effects of Inflation
 Inflation that is not sustainable is a threat to businesses due to the uncertainty
that is caused. The international competitiveness of a country can also be
affected by inflation.
 Example: A nation with high inflation rate than its rival
less price
competitive when trading overseas
fall in export earnings, lower
national output and higher unemployment .
 Inflation can be controlled by limiting demand-pull and cost-push factors.
 Example: Taxes might be raised by the domestic government to control the
amount of consumption in the economy.
High Employment/ Reducing
Unemployment
 The rate of unemployment measures the proportion of a country’s workforce
not in employment. The unemployment rate is caused by the interaction of the
levels of aggregate demand and aggregate supply in the economy.
 If aggregate demand is high: there is a higher level of derived demand for
labour
low unemployment.
 If aggregate supply is high, more national output is being produced
level of employment
higher
Economic and Social Costs of High
Unemployment
 Governments aim to deal with the problems of unemployment as there are both
economic and social costs of high unemployment.
 The costs to society include the effects on the unemployed themselves, such
as stress, depression and low self-esteem.
 Unemployment also affects families and friends with negative effects such
as arguments, separation and divorce.
 It also have a negative impact on the local community, such as poverty and
increased levels of crime.
 Economic costs- refer to the opportunity costs of unemployment.
 What could have been produced if unemployment was not a problem?
 The economic costs of high unemployment might include the increased
burden for taxpayers and increased government spending on unemployment
benefits.
Demand-side and supply-side policies
 Governments can use a combination of demand and supply side policies to tackle the
problems of unemployment.
 Demand-side policies: directly target increasing the level of aggregate demand in the
economy.
 Policies:
 Government may use expansionary fiscal policy to reduce unemployment; this
entail reducing taxes and/or increasing government spending.
 Also, expansionary monetary policy may be used to boost aggregate demand;
reducing the level of interest rates in the economy to encourage consumer and
business borrowing and spending.
 A third demand-side policy is for the government to use protectionist measures
to protect domestic businesses and jobs from international competition, this
might involve placing tariffs (a tax on foreign goods) to give domestic products
a price advantage.
Types of Unemployment
 Frictional or transitional unemployment
 When people are changing jobs as there is usually a time lag between leaving a job
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and finding or starting another.
Seasonal
 Seasonal changes in demand for a product.
 Ex. During the pre-Christmas trading period, temporary staff are employed
but when the season is over these people become unemployed.
Technological
 People lose jobs due to the introduction of labor-saving (capital-intensive)
technologies, which can cause mass scale unemployment.
Regional
 Urban districts tend to have higher levels of employment than remote rural areas.
Structural
 Demand for products produced in a particular industry continually declines, the
industry therefore suffers from structural and long-term changes.
Cyclical or demand deficient (most severe)
 Affects every industry in the economy. It is caused by lack of aggregate demand in
the economy (i.e. economic recession).
Economic Growth
 Economic growth refers to an increase in a country’s economic activity over time. This
is measured by the change in total output of the economy per year, known as the Gross
Domestic Product (GDP).
 Trade/business cycle phases, which shows how economic activity fluctuates over time.
 Peak/boom: Economic activity at highest level
 Recession: Dip in level of economic activity for two consecutive quarters (half a year)
 Slump/trough: Bottom of recession. High level of unemployment, poor liquidity
 Recovery/expansion: When GDP starts to rise again. Everything gradually rises.
Coping With A Recession
 Cost Reduction
 Efforts to cut lighting and energy bills, finding alternative suppliers who
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can offer better prices or relocating to improve cash flow.
Price reduction
 May help to sustain or increase sales.
Non-pricing strategies
 Can help sustain or revitalize volume of sales
Branding
 Impact on sales and reduce the degree of price and income elasticity of
demand.
Outsourcing (production overseas)
 Where costs of production are lower can help a business to gain a
competitive price advantage and to increase its profit.
Growth via Quality of Factors of Production
 Requires an investment in key resources of the economy:
 Capital Goods
The greater the investment levels, the higher economic growth tend to
be.
 Education and Training
 A better educated and trained workforce becomes a more productive
and internationally competitive labour force.
 Health Technology
 Advances in health care helps to ensure workers are healthy and
therefore more productive.
 Also prevent workers having to take time off work or retire early due
to illness.
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Growth via Quantity of Resources
 Changes in Demography
 A fall in the birth rate in developed economies has led to ageing
population and a smaller workforce (and vice versa).
 Changes in Participation Rates
 Measures the number of people who are self-employed or employed as a
percentage of the total labor force.
 Changes in Net Migration
 The difference between immigration* and emigration**. If the net
migration figure is positive, then the size of the workforce will increase,
thus helping to raise the productive capacity of the economy.
o *Immigration: The number of people entering a country for work
purposes.
o **Emigration: The number of people leaving a country.
Barriers To Economic Growth
 Poorer countries and regions of the world have found it difficult to
grow due to existing barriers to economic growth. A country will
find economic growth is more difficult to achieve if:
 Lack of infrastructure (communications and transport networks)
Countries without the basic electricity, road network, schools, etc.
 Lack of technical knowledge and skilled labour force
 Rapid population growth
 Countries with a high net birth rate will tend to find that there are too many
mouths to feed.
 High foreign debt repayments
 High indebted poor countries are obliged to repay their interest-bearing loans,
therefore leaving little money for domestic investment and growth.
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Balance of Payments
Balance of payments is a record of a country’s money inflows and outflows ,per time
period, made up of two components:
 Current Account: Export earnings and import expenditure
 Visible trade balance: tangible goods international trade
o Ex. Oil, steel and cars
 Invisible trade balance: foreign trade in intangible
o Ex. Banking, distribution and insurance
 Capital Account: Flows of money for government reserves, foreign
currencies or investment reasons.
Protectionism
 Protectionism refers to any policy used by a government to safeguard domestic
businesses from foreign competitors.
 Examples of Protectionism:
 Tariffs/customs duties: A form tax placed on imported products.
o This helps to give the domestic firms a slight price advantage.
 Quotas: Quantitative limits preventing too many foreign products
entering a country.
 Subsidies: Payments made by a government to domestic firms as a form
of financial aid.
o This helps reduce the costs of production of domestic firms, thereby
giving them a competitive advantage over foreign rivals.
 Embargos: Physical bans on international trade with a certain country.
o Such restriction are usually due to political conflict, strategic reasons
or severe health and safety concern.
 Tech and safety standards: Imposition of strict technical or health and
safety standards being placed on the import of foreign products.
Environmental Opportunities and Threats
 Without government intervention, private sector businesses are unlikely to consider
the external costs/negative externalities of production. These are costs borne by
society or the environment rather than by the buyer or seller.
 Example of such costs include passive smoking, air and noise pollution,
packaging waste and global warming.
 Public concerns and changes in social attitudes about the environment have meant
that businesses are increasingly reviewing their operations.
Political Opportunities and Threats
 Laissez-faire approach: When a government does not intervene significantly in business
activity.
 Leaving business to their own devices should stimulate healthy competition and
efficacy.
 Fiscal Policy: The use of government taxation and government expenditure policies to
influence the economy. Two classifications of taxation:
 Direct - Paid straight from income, wealth or profit of an individual or a business.
 Indirect - Refers to tax paid on the trade in good and services.
 Progressive- Proportion of tax paid increases as income, wealth or profit of
taxpayer rises.
 Regressive- Proportion falls as income of taxpayer rises
 Proportional- The percentage of tax paid remains the same, irrespective of
income, wealth or profit levels.
Two Forms of Fiscal Policy:
 Deflationary is used when the economy is experiencing high rates of
economic growth and inflation, so needs to be slowed down.
 i.e. via a combination of higher taxes and reduced government
expenditure policies.
 By contrast, expansionary is used to boost economy, by a combination of tax
cuts and more public sector spending.
Common Examples of Taxes:
 Income tax: A levy on personal incomes from wages, rent, interest and
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dividends.
Corporation tax: A levy on the profit of businesses.
Sales tax: Taxes on an individual’s expenditure.
Capital gains tax: Tax on the surplus made from investments in shares and
other assets.
Inheritance Tax: A tax on the value of assets passed onto another party
following the death of an individual.
Excise Duties: Taxes are levied on demerit goods such as alcohol.
Customs Duties: Taxes on foreign imports.
Stamp Duty: A tax paid when commercial or residential property is bought.
Monetary Policy
 Monetary policy is designed to control the amount of spending and investment
in an economy by altering interest rates to affect the money supply and
exchange rates.
 Businesses are charged varying levels of interest rates for four main reasons:
 1. Risk: The greater the risk of a business defaulting on a loan, the
greater interest rate tend to be.
 2. Time: The longer the period of a loan, the higher the real interest rate
 3. Administration costs: higher these are in lending money to a business,
the higher the interest rate.
 4. Expectations: if government expects good economy, likely to
announce an interest rate hike to dampen the effects on inflation in the
economy.
Legal Opportunities and Threats
 Common legislation affecting businesses include:
 Consumer protection legislation: Laws exist that make it illegal for a
business to provide false or misleading descriptions of their products
and services.
 Employee protection legislation: Laws have been passed to protect
the interest and safety of workers.
 Competition legislation: Laws ensure that anti-competitive practices
are stopped in order to protect customers and smaller firms.
 Social and environment protection legislation: Laws exist to prevent
or reduce the consumption of demerit goods.
Ethical Opportunities and Threats
 Business ethics are the moral principles that should be considered in business
decision-making.
 Although there are compliance costs in acting ethically, firms that are
responsible can benefit in several ways:
 Attract/retain good quality workers
 Attract new consumers, retain customers
 Generates good publicity and public relations
 Businesses only report only figures for financial performance, but now also
prepare to have external social audits conducted.
Differences between PEST and SWOT:
 SWOT analysis is a frequently used decision-making tool.
 Acronym for: strengths, weakness, opportunities, and threats
 PEST is broader and examines all factors, SWOT is a much narrower focus
 PEST helpful to produce SWOT (NOT vice versa)
 PEST identifies opportunities and threats in SWOT
 PEST more useful and relevant with larger/ complex issues
 PEST doesn’t directly consider internal factors of issue considered.
External Environment and Business
Strategy
 PEST gives managers an overview of the external business
environment, the factors that might affect business activity and the
issues that should be addressed in any business strategy.
 It can be used to analyze decisions such as:
 Potential costs and benefits of a joint venture, merger, or
acquisition
 Marketing planning
 Business propositions
 Investment opportunities
Policies to achieve macroeconomic
objectives:
 Governments will use a range of policies to achieve their macroeconomic
objectives. Some will present threats, whilst others will be opportunities for
businesses.
 This will largely depend on factors such as:
 Size of business
 Ability of management
 Price elasticity of demand
 Degree of diversification
 Level of a firm’s gearing
 External factors affect international competitiveness of business.
Review Questions
 1. What does the acronym STEEPLE analysis stand for?
 2. Outline the purpose of a PEST analysis.
 3. What are the three general steps needed to carry out a PEST analysis?
 4. Explain how each of the PEST components can represent either
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opportunities or threats for a business.
5. What are the four key macroeconomic objectives of most governments?
6. What is meant by “trade cycle”?
7. State 3 ways in which a business may be able to cope with a recession.
8. Using examples, distinguish between ‘economic’ and ‘political’
opportunities and threats.
9. Distinguish between ‘fiscal policy’ and ‘monetary policy’.
10. How does the legal system present both opportunities and threats for
businesses?
Key Terms
 Balance of Payment: An annual record of a country’s export earnings and its
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import expenditure. A surplus exists if the value of exports exceeds that of
imports.
Deregulation: The removal of government rules and regulations which
constrain an industry, thereby enhancing its efficiency.
Direct Tax: A levy hat is paid from the income of individuals or businesses,
such as personal income tax and corporation tax.
Economic Growth: Measures the change in the Gross Domestic Product of a
nation over time. Growth is said to occur if there is an increase in GDP for
two consecutive quarters.
Ethics: The moral values and judgments that society believes organizations
should consider in their decision-making.
Exchange rate: The value of country's currency in terms of another currency.
External shocks, aka exogenous shocks: Unforeseeable and unexpected
changes in the external business environment that tend to affect all businesses
in the economy, such as natural disasters or wars.
 Fiscal Policy: Government policies that deal with taxation and government
expenditure in order to affect the level of economic activity.
 Gross Domestic Product: The total value of a nation's annual output. It is used
as an indicator of the level of economic activity in a country.
 Indirect Tax: A levy placed on the purchase of goods and services, such as sales
taxes and excise duties.
 Inflation: When the general price level in an economy continuously rises. It is
calculated by measuring changes in the cost of a representative basket of goods
and services purchased by the average household over a period of time.
 Interest Rate: A measure of the price of money. It can be expressed in terms of
the amount charged for money that is borrowed or how much is offered on
money that is saved.
 Monetary Policy: Government policies concerned with changing interest rates in
order to control the money supply, and the exchange rate.
 PEST analysis- a framework used to analyze the opportunities and threats of
the political, economic, social, and technological environments on business
activity. It is one of many tools that can be used in the decision-making
process.
 Protectionism- refers to any measure taken by a government to safeguard its
businesses from foreign competitors. This presents a threat or barrier to
trade for businesses trying to operate in overseas markets.
 Tariffs- a method of protectionism whereby the domestic government taxes
foreign imports, thereby giving domestic producers a relative price
advantage.
 Trade cycle, aka business cycle- the fluctuation in the level of economic
activity over time. Economies tend to move through the cycle of booms,
recessions, slumps, recovery and growth.
 Unemployment- the number of people in the workforce who are willing and
able to work but cannot find employment.