Download Financial Strategies and accounts Understanding Financial

Assessing Changes in the Business
Environment
The Relationship between Businesses
and the Economic Environment
“Trickle down theory – the less than elegant metaphor that if
one feeds the horse enough oats, some will pass to the road for
the sparrows.”
JK Galbraith
“The market is a mechanism for sorting the efficient from the
inefficient, it is not a substitute for responsibility.”
Charles Handy
BUSS4.2 Economic Environment
In this topic you will learn about:

Assessing the effects of the following factors on
business organisations:
• Impact of economic factors
• Trends in key economic variables
• Globalisation of markets
• Developments in emerging markets

Evaluating the strategies businesses might deploy
in response to these changes.
BUSS4.2 Economic Environment
The Impact of Economic Variables on a
Business Organisation

Up until this point you have largely focussed on internal
factors affecting business behaviour. In this unit you are
going to look at the wider impacts starting with the
economic environment

The economic environment consists of many key factors
that influence the behaviour of businesses and their
customers. These include:
◦
◦
◦
◦
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The Business Cycle
Interest Rates
Exchange Rates
Inflation
Unemployment
Economic Growth
The economic
environment effects
business and
customer behaviour
BUSS4.2 Economic Environment
Business Cycle




Real
GDP
The level of economic activity fluctuates over time, this
pattern is referred to as the business cycle
Economic activity is measured by GDP (Gross Domestic
Product)
GDP is the total value of a country’s output in a year
Real GDP takes into account inflation. If GDP growth is
5% and inflation 2% real GDP growth will be 3%.
There are four main stages to the Business Cycle:
Trend rate of
economic growth
Boom
Recovery
Slump
Recession
Time
BUSS4.2 Economic Environment
Business Cycle - Boom

A period of high levels of economic activity

Characterised by:
High rate of economic growth
High demand
Low unemployment
Inflationary pressure
Once you have studied each
of the economic variables in
turn you may wish to revisit
the business cycle to discuss
why some of these
characteristics of a boom in
time lead to a downturn
Labour skills shortages
High confidence in the economy
Capital Investment is high
BUSS4.2 Economic Environment
Business Cycle – Boom
Business impact

Firms struggle to find skilled workers

Capacity utilisation is close to full capacity due to
the high rate of economic growth

Demand is more price inelastic - price becomes
less significant

Quality will be seen as more attractive

More difficult to retain staff as firms compete for
workers – wages are bid up
BUSS4.2 Economic Environment
Business Cycle - Recession

The rate of economic growth starts to fall in a downturn

If real GDP falls for 6 months then this is known as a recession

Characterised by:
 Demand falls
 Unemployment begins to rise
The worst recession in
the UK since 1979
 Some firms will go out of business
 Confidence in the economy is low and most firms will reduce investment
1979 saw the start of
Britain’s decline into a
recession – mirrored in the
music of the day
Ghost Town The Specials
The Government state that recession is
officially two quarters of negative economic
growth. However, it is often regarded as a
period of low economic growth.
BUSS4.2 Economic Environment
Business Cycle – Recession
Business impact

Firms will rationalise – laying off workers and reducing capacity

Cost minimisation will become a key factor

Demand is more price elastic - price becomes more significant

‘Value for money’ will be seen as more attractive

Staff fear for their jobs and motivation will be affected
Corus job losses
What actions has the business taken to try and avoid job losses?
What is the likely knock on effect of the job losses in the local
area?
BUSS4.2 Economic Environment
Business Cycle - Slump
 The
bottom of the business cycle which represents a
period of serious economic decline
 Characterised
by:
Low or negative growth
Demand and inflation are low
Unemployment is high
Confidence in the economy is low
High rate of bankruptcy
Why is the housing
market frequently
quoted as a key
indicator of economic
activity?
BUSS4.2 Economic Environment
Business Cycle – Slump
Business impact

Many firms have gone out of business – less competition for
those who survive

Many more are fighting for survival

Price is pre-eminent for many firms

However, less competition leads to monopoly and oligopolistic
(few firms in an industry) markets

Wage costs are lower as too many workers vie for too few jobs
BUSS4.2 Economic Environment
Business Cycle - Recovery
When there are signs that economic growth is starting to rise,
often referred to as the ‘green shoots of recovery’

Economic growth starts to rise

Demand increases

Unemployment falls

Inflation starts to rise

Confidence in the economy increases

Capital Investment increases
Why is business
confidence so
important for a
recovery?
BUSS4.2 Economic Environment
Business Cycle – Recovery
Business impact

Firms will take on more workers

Capacity utilisation increases

Investment in all areas starts to increase

Price begins to be a less important factor
BUSS4.2 Economic Environment
Evaluating strategies that businesses might deploy in
response to changes in the business cycle
Recovery/Boom
Increase capacity utilisation – can the firm afford to take on new workers
and increase production? This will depend on other factors such as the
finance available, particularly in the short-run
Increase capacity – can the firm afford to invest in capital equipment?
This will require longer term sources of finance. Gearing will be a
significant issue here
Target new markets – Ansoff’s Matrix can be used to look at business
strategy here. The firm might develop new products with a high positive
income elasticity e.g. luxury goods
Increase price – what is the price elasticity of the product? As the
economy grows price become less important to customers
BUSS4.2 Economic Environment
Evaluating strategies that businesses might deploy in
response to changes in the business cycle
Recession/Slump
Cut capacity – there is an opportunity cost involved. Will the recession be
short lived? Once changes have been made they are often difficult to
reverse
Lay off workers – this can cause demotivation and initial cash flow
problems with high redundancy costs
Target new markets – Ansoff’s Matrix can be used to look at business
strategy here
Reduce price – what is the price elasticity of the product. This could lead
to price wars where only the consumer benefits. Not everyone suffers in
a recession! Are the firm reducing the price of a price inelastic product?
Go on a buying spree! – takeover activity often increases in a recession –
other companies are suddenly a bargain!
BUSS4.2 Economic Environment
Economic Variables
- Interest Rate
What is it?
The price of money - the cost of borrowing or the reward for saving money
How do interest rates affect a business?

Gearing
 firms that have high gearing are sensitive to interest rates

Supply
 if the cost of borrowing increases it becomes more expensive to invest in capital equipment
 B2B (Business to Business) transactions will fall as firms buy less capital goods and there will be
less capacity in the economy

Demand
 higher interest rates will mean that consumers have less disposable income e.g. higher mortgage
payments and therefore fall in demand for other products

Exchange rates
 higher interest rates mean that foreign investors will invest in UK banks for higher returns
 an increase in demand for the £ will see its value appreciate – making exports dearer
BUSS4.2 Economic Environment
How do interest rates effect
consumer spending?

Gross wage – compulsory deductions e.g. tax, NI and pensions =
Net or take home wage. We call this disposable income.
Net wage – compulsory payments e.g. mortgage, loan repayments,
insurance etc = Discretionary income i.e. the proportion of our
wage that we spend at our discretion
As interest rates go up our discretionary income goes down

Interest rates also affect our ability and willingness to buy on credit


Look at the items of expenditure below. Rank these in an order to show how likely it
is demand will fall for them if interest rates go up. Justify your ranking.
Milk, Cigarettes, Daily Newspaper, Freezer, Petrol, Cinema tickets, Restaurant meal,
New car, School shoes, Designer jacket, Gym membership, Packet of crisps, Sofa,
Light bulbs, Organic vegetables, DIY equipment
BUSS4.2 Economic Environment
Economic variables
- Exchange Rates
What is it?
The price of one currency in terms of another e.g. £1 = $1.50
An increase in the value of a currency is called an appreciation and
means the currency is worth more e.g. £1 = $1.60
A decrease in the value of a currency is called a depreciation and
means the currency is worth less e.g. £1 = $1.40
How do exchange rates affect a business?
 SPICED (strong pound: imports cheaper, exports dearer)
 Firms that import will be able to buy cheaper raw materials and
finished goods
 Firms that export will see less demand
 WPIDEC (weak pound: imports dearer, exports cheaper)
There will be greater demand from abroad for UK goods
 Input prices will increase if raw materials are imported
 If the firm has a price inelastic product it will be able to pass the
increase in costs onto the consumer
Explain why a depreciation of the Pound will
lead to increased tourism from the EU
BUSS4.2 Economic Environment
Economic variables - Inflation
What is it?
A general rise in prices or a fall in the value of money
There are two main types of inflation:
• Cost push – an increase in input prices e.g. raw materials and wages
• Demand pull – an increase in demand allowing firms to raise prices
There are two main measurements:
 Retail Price Index (RPI) – a measurement of a ‘basket’ of goods and
services representative of what people buy in the UK

Consumer Price Index (CPI) – similar to RPI but mainly excluding housing
costs
Explain the relationship between inflation,
pay and cost of living.
What happens to inflation in a recession?
BUSS4.2 Economic Environment
Economic variables - Inflation
How inflation affects a business:

The Government have set an inflation target of 2%. The Bank of
England’s Monetary Policy Committee (MPC) meet once a month to
decide the Bank’s Rate of Interest. If CPI is too high they might raise
interest rates to reduce the rate of inflation

Increased costs due to higher inflation can be passed onto the consumer
if the product is price inelastic. If not the firm will have to try and
absorb the increased costs through lower profit margins

Clearly, this has an impact on the pricing strategy of a firm. Some firms
will reduce the supply of the product, having a major affect on operations
management as capacity is reduced and the firm rationalises with a
greater focus on cost minimisation

It becomes increasingly difficult to maintain competitiveness. Demand
will fall if the firm has to raise price. If it exports then it will see
customers move to companies abroad where prices are not rising as fast
BUSS4.2 Economic Environment
Economic variables - Unemployment
What is it?
Those people looking for work who cannot find a job.
It can be measured in two main ways:
Claimant count – those claiming Unemployment Benefit
• Labour Force Survey – those without a job, want a job, have sought work in the
last 4 weeks and are available to start work in the next 2 weeks
•
http://www.statistics.gov.uk/downloads/theme_labour/unemployment.pdf
How unemployment affects a business:
 Skills shortage/surplus – too few workers will lead to less suitable
skills for the position, too many plenty of choice
 Demand – high unemployment leads to less demand and vice-versa
 High/low costs – wage rates are affected by the number of people
available for a position
Use the evidence presented in these BBC clips to
discuss the affects listed above
BUSS4.2 Economic Environment
Economic variables - Unemployment
Types of unemployment:
 Structural – this occurs because of fundamental changes to the
economy and whole industries are in decline
 Cyclical – this is linked to the business cycle and occurs due to
the position on the cycle e.g. slump equals high unemployment
 Frictional – this occurs when people are unemployed as they
are moving between jobs. With a job awaiting them, this type of
unemployment does not have a major impact on the economy
 Seasonal – as we move through the seasons different kinds of
job are created or lost e.g. holiday jobs due to the summer
The Chief US Economics
advisor gives advice on
economics
BUSS4.2 Economic Environment
Economic variables - Economic
Growth
What is it?
A rise in the value of Gross Domestic Product (GDP)
This measures the value of goods and services produced in an economy
each year.
How economic growth affects a business:

Demand – consumers will have more disposable income e.g. higher wages.
Firms will have higher profits which can be reinvested

New business start-ups – more new firms will be created due to
confidence in the state of the economy

Inflation – higher demand in the economy can lead to skills shortages and
demand-pull inflation

Negative economic growth occurs when the value of GDP starts to fall. If
this occurs for at least two quarters of a year i.e. 6 months we are officially
in a recession
BUSS4.2 Economic Environment
Globalisation of markets
Remember, questions should be answered about the
impact on the firm NOT the impact on the UK economy

Globalisation is the integration of international economies leading to a
world market in goods and services

This has meant that markets are increasingly global i.e. trading and/ or
operating internationally

Greater interdependency amongst countries – they rely on each other

Globalisation has led to the movement and exploitation of factors of
production by Multinational Corporations (MNCs) around the world
BUSS4.2 Economic Environment
Globalisation of markets
Benefits of Globalisation

Opportunities to sell into new markets

Economies of scale as the firm grows globally

Global marketing strategies can be used

Cheaper raw materials from low cost countries

Cheaper labour costs abroad

Free movement of labour providing cheap labour in the UK

Off-shoring provides greater scope for optimal location
Look at one of the UK’s large supermarkets. Choose three different
products. How have the factors of production used in putting these
products into the supermarket been exploited on a global basis?
BUSS4.2 Economic Environment
Globalisation of markets
Disadvantages of Globalisation

Increased competition – although this can make firms more efficient

‘Global localisation’ – altering products to meet local tastes - may be
required to meet local cultures

Communication and transport problems

Firms can gain a bad reputation for making UK workers redundant

Exploitation of foreign workers can lead to criticism of being unethical

Exploitation of the global environment can lead to bad publicity
Are business leaders in France
right to fear globalisation?
HSBC The world’s local bank.
Can Global localisation be a
strength of a business?
BUSS4.2 Economic Environment
Developments in emerging markets
An emerging market is a country with low to middle per capita income
(Average income per person) Antoine Van Agtamael - World Bank (1981)
This refers to 80% of the World’s population but only 20% of its countries.
Emerging markets are seeing rapid growth through economic reform. They
are emerging from ‘closed’ economies (no international trade) to ‘open’
economies (increasing international trade)
This encompasses the BRIC countries (Brazil, Russia, India and China) as well
as smaller nations such as Pakistan, Peru and Singapore
HSBC The world’s local bank moves into
emerging markets
BUSS4.2 Economic Environment
Developments in emerging markets
How can an emerging market benefit UK firms?
In terms of the Boston Matrix many emerging markets can be seen as
rising stars. They have in common:

Rapidly rising consumer incomes

Fast growing markets

Exploitable natural resources

Exploitable cheap labour
Rising Star
High Market Growth
High Market Share
BUSS4.2 Economic Environment
Developments in emerging markets
However emerging markets can cause UK firms problems
In terms of the Boston Matrix emerging markets can also become
problem children or even dogs:

Poor infrastructures e.g. transport and communication

Political instability

Accusations of exploitation from an ethical and environmental
perspective

Cultural and legal differences
BUSS4.2 Economic Environment
ACTIVITY – Economic
Environment Terminology
You have been introduced to a lot of new terminology in this unit, it is
important that you are confident with the language of accounts before
moving onto the next unit.
1.
Draw a mind map to summarise the terminology you have been
introduced to in this unit, make sure that all the correct terms
are included, with explanations and examples where
appropriate.
2.
As a class individually draw a grid with 9 squares in it - put in 9
words to do with the economic environment in a random order
Nominate one person or the teacher to call out words or
definitions. As they appear on your grid cross them off as if
playing bingo.
3.
BUSS4.2 Economic Environment
Essay
In 2007 Costa Coffee opened its first
store in China with plans to open a total
of 300. Chief executive Alan Parker said
"China is a very attractive market, making
this a major deal for Costa.” With
reference to Costa Coffee and/or other
businesses you have studied to what
extent do you agree that emerging
economies are attractive markets for
global expansion. Justify your answer.
BUSS4.2 Economic Environment