External Environment (Unit 1.5)

Ambar DeleonPeriod 5

Internal Factors 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:

1. Finance: Most firms lack sufficient sources of finance. Firms can either seek additional sources of finance or use alternative ways to achieve their objectives.

2. People: Poor working relations harms a firms ability to achieve their goals. Motivational strategies can help towards improving conflicts in the workplace.

3. Marketing: Their marketing campaigns are not as attractive as their rivals, such as interior products, packaging, customer service and promotions.

4. 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 AnalysisPEST is an acronym for the Political, Economic, Social and Technologicalopportunities 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.

Economico The state of the economy in which business operate is determine by four key

variables: inflation, unemployment, economic growth and international trade. Socialo Social, cultural and demographic changes can also present opportunities or

threats to a business Technologicalo 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 businesso 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 processMarketing: E-commerceFinance: annual reports published onlineOperations 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 crimeHigher 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 practicesExample: 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 inflationo 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 inflationo 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 higher level of employment

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 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.

TechnologicalPeople lose jobs due to the introduction of labor-saving

(capital-intensive) technologies, which can cause mass scale unemployment.

RegionalUrban 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 levelRecession: Dip in level of economic activity for two consecutive quarters

(half a year)Slump/trough: Bottom of recession. High level of unemployment, poor

liquidityRecovery/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 can offer better prices or relocating to improve cash flow.

Price reductionMay help to sustain or increase sales.

Non-pricing strategiesCan help sustain or revitalize volume of sales

BrandingImpact 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 ProductionRequires an investment in key resources of

the economy:Capital Goods

The greater the investment levels, the higher economic growth tend to be.

Education and TrainingA 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.

Growth via Quantity of Resources

Changes in DemographyA 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 forceRapid population growth

Countries with a high net birth rate will tend to find that there are too many mouths to feed.

High foreign debt repaymentsHigh indebted poor countries are obliged to repay their

interest-bearing loans, therefore leaving little money for domestic investment and growth.

Balance of PaymentsBalance 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 tradeo Ex. Oil, steel and cars

Invisible trade balance: foreign trade in intangibleo 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 risesProportional- 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 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 rate3. 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 workersAttract new consumers, retain customersGenerates 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

acquisitionMarketing planningBusiness propositionsInvestment 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 businessAbility of managementPrice elasticity of demandDegree of diversificationLevel 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

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

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.