Business Environment

-Environment literally means the surroundings, external objects, influences or circumstances under which
someone or something exists. The environment of any organization is “the aggregate of all conditions,
events and influences that surround and affect it.” Davis, K, The Challenge of Business, (New York: McGraw
Hill, 1975), p. 43.
-Environment refers to all external forces which have a bearing on the functioning of business.
-The environment includes factors outside the firm which can lead to opportunities or a threat to the firm.
Although there are many factors the most important of the sectors are socio-economic, technological,
supplier, competitor and govt.
 
So, it is quite obvious that success in a business depends upon better understanding of the environment.
A successful organization doesn’t look at the environment on an ad hoc basis but develops a system to
study the environment on a continuous basis to try and protect the organization from every possible
threat and to take the advantage of every opportunity. Some times better and timely understanding of
the environment can even turn a threat into an opportunity.

Importance of business environment

1. Environment is Complex:  The environment consists of a number of factors, events, conditions and
influences arising from different sources. All these interact with each other to create new sets of
influences.
2. It is Dynamic:  The environment by its very nature is a constantly changing one. The varied influences
operating upon it impart dynamism to it and cause it to continually change its shape and character.
3. Environment is multi -faceted:  The same environmental trend can have different effects on different
industries. For instance, GATS is an opportunity for some companies but a threat for others.
4. It has a far-reaching impact:  The environment has a far-reaching impact on organizations in that the
growth and profitability of an organization depends critically on the environment in which it exists.
5. Its impact on different firms within the same industry differs:  A change in environment may have
different bearings on various firms operating in the same industry.
6. It may be an opportunity as well as a threat to expansion:  Developments in the general
environment often provide opportunities for expansion in terms of both products and markets.
7. Changes in the environment can change the competitive scenario:  General environmental changes
may alter the boundaries of an industry and change the nature of its competition.
8. Sometimes developments are difficult to predict with any degree of accuracy:  Macroeconomic
developments such as interest rate fluctuations, the rate of inflation, and exchange rate variations are
extremely difficult to predict on a medium or a long-term basis. On the other hand, some trends such as
demographic and income levels can be easy to forecast.

Analysis of the external environment

Analysis of the external environment

The external environment of the enterprise can itself be divided into two parts

1. The general environment - The general environment, viewed from an economic perspective, consists of
a whole series of different industrial environments.

2. The competitive (industrial) environment- The competitive environment is made up of the immediate
competitors of an enterprise. Industries overlap national boundaries
Enterprises must position themselves appropriately in the external environment in order to make an
above-normal rate of return, one which gives a guarantee of their continued existence.

Positioning involves location as to both industry and country and comprises identification of an

Some interpretations of strategy see positioning as the essential feature of strategy design. The work of
Michael Porter is closely associated with this point of view. Positioning involves a range of different
strategic decisions – the choice of product or service, market or even market segment, location of various
facilities concerned with production and selling and, not least, the choice of a specific technology. In this
sense reading the external environment could be said to determine the nature of the strategy. On these
accounts the external environment is at the very least the starting point for the articulation of any
particular strategy.

Segmentation of the general environment

The analysis/segmentation of the general environment is called PEST, but more accurately STEP, the four
main segments are identified:
-Social
-Technical
-Economic
-Political-.

Characteristics of general environment

1. Complexity -The complexity arises from the multiple interactions between different segments of the
general environment. It is common to see change as resulting from segments of the environment which
are already an immediate focus of interest. For example, a strategist may be tempted to read the
environment simply as an economic environment and other segments as irrelevant. This is a mistake. The
nature of the interaction which produces the flow of global events and trends is difficult to read clearly. It
involves many different elements and complicated interactions between different segments.
 There are numerous ways in which the general environment influences the profitability of an enterprise,
or the profitability of future ventures likely to be undertaken by the enterprise. Many of these influences
are indirect, not immediately obvious to the observer. The pathway of causation may be very circuitous.
The general environment is amazingly complex, particularly, but not only, at the global level.

 2. Uncertainty- There is significant ambiguity and uncertainty. The nature or strength of the pressures
building beneath the business landscape is far from obvious. The sources of these pressures can be
anything from a change in the birth rate to major technical breakthroughs. Sometimes the economy is
overwhelmed by catastrophic events, such as war or a general depression, which may have causes which
are complex and not simply a reflection of economic change. Understanding change is not simply a
matter of observing the symptoms of that change and detecting patterns in it. It is much more a matter of
recognizing in a series of apparently unrelated events relevant chains of cause and effect.

 3. Rapid change- The general context is a dynamic one. It offers both threat and opportunity. Change is
imposed upon the enterprise by the instability of the environment in which the enterprise has to survive.
The enterprise has no choice but to change with its environment  or cease to exist. The trick is to ride the
wave of change, exploiting the opportunities which arrive with the change and controlling the threats. It is
essential that any enterprise anticipates all the threats which loom on the horizon and rapidly change the
relevant context:
• extreme political events such as revolution or war
• the appearance of a new product or technology, or rather a family of products or Processes 
 a fundamental market change, say a shift from inflation to deflation difficulties in factor markets
• a worsening shortage of labour
• a change in the level of government regulation
• the appearance of a new competitor or competitors, sometimes from abroad.

Very often a threat is associated with an opportunity, the chance of moving into a new area of profit. This
is not uncommon. The difference between opportunity and threat is not very great. Failing to anticipate
significant events is not just a matter of missing a chance for enhanced profit, it is often a sure
prescription for disaster.

On occasions the unanticipated changes are political, sometimes demographic, sometimes simply
economic, sometimes all of these rolled into one. The relevant parts of the general environment are broad
indeed. These interactions have little stability; they change their nature from moment to moment, so that
the environment never returns to what it was before. Each momentary context is unique. Each period of
time has its own characteristic pace of change, its own mix of stability and volatility. It is often unclear
what will be the source of the next change and what impact it will have on the business landscape. It is
hard to make an accurate prediction if there is no understanding of the causes of the instability.
 Five forces that affects firm’s competitiveness

1. Threat of new entrants

Each of these forces affects a firm’s ability to compete in a given market. Together, they determine the
profit potential for a particular industry. To understand industry competition and profitability, one must
analyze the industry’s underlying structure in terms of the five forces.
 Porter argues that the stronger each of these forces are, the more limited is the ability of established
companies to raise prices and earn greater profits. With Porter’s framework, a strong competitive force
can be regarded as a threat because it depresses profits. A weak competitive force can be viewed as an
opportunity because it allows a company to earn greater profits. The strength of the five forces may
change with time as industry conditions change.

1. The Threat of New Entrants:  The first of Porter’s Five Forces model is the threat of new entrants. New
entrants bring new capacity and often substantial resources to an industry with a desire to gain market
share. Established companies already operating in an industry often attempt to discourage new entrants
from entering the industry to protect their share of the market and profits. Particularly when big new
entrants are diversifying from other markets into the industry, they can leverage existing capabilities and
cash flows to shake up competition. Pepsi did this when it entered the bottled water industry, Microsoft
did when it began to offer internet browsers, and Apple did when it entered the music distribution
business.

The threat of new entrants, therefore, puts a cap on the profit potential of an industry. When the threat is
high, existing companies hold down their prices or boost investment to deter new competitors. And the
threat of entry in an industry depends on the height of entry barriers (i.e. factors that make it costly for
new entrants to enter industry) that are present and on the retaliation from the entrenched competitors. If
entry barriers are low and newcomers expect little retaliation, the threat of entry is high and industry
profits will be moderate. It is the threat of entry, not whether entry actually occurs, that holds down
profitability.

2. Intensity of Rivalry among Competitors:   The second of Porter’s Five-Forces model is the intensity of
rivalry among established companies within an industry. Rivalry means the competitive struggle between
companies in an industry to gain market share from each other. Firms use tactics like price discounting,
advertising campaigns, new product introductions and increased customer service or warranties. Intense
rivalry lowers prices and raises costs. It squeezes profits out of an industry. Thus, intense rivalry
among established companies constitutes a strong threat to profitability. Alternatively, if rivalry is less
intense, companies may have the opportunity to raise prices or reduce spending on advertising etc. which
leads to higher level of industry profits.

3. Bargaining power of buyers:  The third of Porter’s five competitive forces is the bargaining power of
buyers. Bargaining power of buyers refers to the ability of buyers to bargain down prices charged by firms
in the industry or driving up the costs of the firm by demanding better product quality and service. By
forcing lower prices and raising costs, powerful buyers can squeeze profits out of an industry. Thus,
powerful buyers should be viewed as a threat. Alternatively, if buyers are in a weak bargaining position,
the firm can raise prices, cut costs on quality and services and increase their profit levels. Buyers are
powerful if they have more negotiation leverage than the firms in the industry, using their clout primarily
to pressure price reductions. According to Porter, buyers are most powerful under the following
conditions:

(a) There are few buyers:  If there are few buyers or each one does bulk purchases, then they have more
bargaining power. Large buyers are particularly powerful in industries like telecommunication equipment,
off-shore drilling, and bulk chemicals. High fixed costs and low marginal costs increase the pressure on
rivals to keep capacity filling through discounts.
 (b) The products are standard or undifferentiated:  If the products purchased from the firm are standard or
undifferentiated, the buyers can easily find alternative sources of supplies. Then buyers can play one
company against the other, as in commodity grain markets.

 (c) The buyer faces low switching costs:  Switching costs lock the buyer to a particular firm. If switching
costs are low, buyers can easily switch from one firm’s product to another.

 (d) The buyer earns low profits:  If the buyer is under pressure to trim its purchasing costs, the buyer is
price sensitive and bargains more.

 (e) The quality of buyer’s products:  If the quality of buyer’s product is little affected by industry’s products,
buyers are more price sensitive. Most of the above sources of buyer power can be attributed to
consumers as a group as well as to industrial and commercial buyers. The buying power of retailers is
determined by the same factors, with one important addition. Retailers can gain significant bargaining
power over manufacturers when they can influence consumers. Purchasing decisions as they do in audio
components, jewellery, appliances, sporting goods etc., are examples.

 4. Bargaining power of suppliers:  The fourth of Porter’s Five Forces model is the bargaining power of
suppliers. Suppliers are companies that supply raw materials, components, equipment, machinery and
associated products. Powerful suppliers make more profits by charging higher prices, limiting quality or
services or shifting the costs to industry participants. Powerful suppliers squeeze profits out of an industry
and thus, they are a threat. For example, Microsoft has contributed to the erosion of profitability among
PC makers by raising prices on operating systems. PC makers, competing fiercely for customers, have
limited freedom to raise their prices accordingly.

A supplier’s bargaining power will be high under the following conditions:

 (a) Few suppliers:  When the supplier group is dominated by few companies and is more concentrated
than the firms to whom it sells, an industry is called concentrated. The suppliers can then dictate prices,
quality and terms.
 (b) Product is differentiated:  When suppliers offer products that are unique or differentiated or built-up
switching costs, it cuts off the firm’s options to play one supplier against the other. For example,
pharmaceutical companies that offer patented drugs with distinctive medical benefits have more power
over hospitals, drug buyers etc.
 (c) Dependence of supplier group on the firm:  When suppliers sell to several firms and the firm does not
represent a significant fraction of its sales, suppliers are prone to exert power. In other words, the supplier
group does not depend heavily on the industry for revenues. Suppliers serving many industries will not
hesitate to extract maximum profits from each one. If a particular industry accounts for a large portion of
a supplier group’s volume or profit, however, suppliers will want to protect the industry through
reasonable pricing.
(d) Importance of the product of the firm:  When the product is an important input to the firm’s business or
when such inputs are important to the success of a firm’s manufacturing process or product quality, the
bargaining power of suppliers is high.
 (e) Threat of forward integration:  When the supplier poses a credible threat of integrating forward, this
provides a check against the firm’s ability to improve the terms by which it purchases.
 (f) Lack of substitutes:  The power of even large, powerful suppliers can be checked if they compete with
substitutes. But, if they are not obliged to compete with substitutes as they are not readily available, the
suppliers can exert power.

 5. Threat of substitute products:  The fifth of Porter’s Five Forces model is the threat of substitute
products. A substitute performs the same or a similar function as an industry’s product. Video conferences
are a substitute for travel. Plastic is a substitute for aluminum.

E-mail is a substitute for a mail. All firms within an industry compete with industries producing substitute
products. For example, companies in the coffee industry compete indirectly with those in the tea and soft
drink industries because all these serve the same need of the customer for refreshment. The existence of
close substitutes is a strong competitive threat because this limits the price that companies in one
industry can charge for their product. If the price of coffee rises too much relative to that of tea or soft
drink, coffee drinkers may switch to those substitutes.
The more attractive is the price/performance ratio of substitute products, the more likely they affect an
industry’s profits. In other words, when the threat of substitutes is high, industry profitability suffers. If an
industry does not ward off the substitutes through product performance, marketing, price or other means,
it will suffer in terms of profitability and growth potential in the following circumstances:

 (b) The buyer’s switching costs to the substitutes is low:  For example, switching from a proprietary,
branded drug to a generic drug usually involves minimum switching costs.

Thus, according to Porter, “substitutes limit the potential returns of an industry by placing a ceiling on the
prices firms in the industry can profitably charge”. For example, the price of tea puts a ceiling on the price
of coffee. To the extent that switching costs are low, substitutes may have a strong effect on the
profitability of an industry.

 (a) It offers an attractive price and performance:  The better the relative value of the substitute, the worse is
the profit potential of the industry. For example, long distance telephone service providers suffered with
the advent of Internet-based phone services.

In essence, the job of the strategist is to understand and cope with competition. However, managers
define competition too narrowly, as if it occurs only among today’s direct competitors. Yet competition
for profits goes beyond established industry rivals. It includes four other competitive forces as well:
customers, suppliers, potential entrants and substitutes.

         The Five Forces model developed by Michael E. Porter has been the most commonly used analytical
tool for examining competitive environment. According to this model, the intensity of competition in an
industry depends on five basic forces. These five forces are:

Analysis of the industry competition

 Competitive analysis basically addresses two questions:

 The degree of competition in an industry is influenced by a number of forces. To establish a strategic

Each business operates among a group of firms that produce competing products or services known as an
“industry”. An industry is thus a group of firms producing similar products or services. By similar products
we mean products that customers perceive to be substitutes for one another.      

Although there are usually some differences among competitors, each industry has its own set of “rules of
combat” governing such issues as product quality, pricing and distribution. This is especially true in
industries that contain a large number of firms offering standardized products and services. As such, it is
important for strategic managers to understand the structure of the industry in which their firms operate
before deciding how to compete successfully. Industry analysis is therefore a critical step in the strategic
analysis of a firm.

In a perfect world, each firm would operate in one clearly defined industry. However, many firms compete
in multiple industries, and strategic managers in similar firms often differ in their conceptualization of the
industry environment. In addition, the advent of Internet has completely changed the way business is
done. As a result, the process of industry definition and analysis can be specially challenging when
internet competition is considered.

The basic purpose of industry analysis is to assess the strengths and weaknesses of a firm relative to its
competitors in the industry. It tries to highlight the structural realities of particular industry and the extent
of competition within that industry. Through industry analysis, an organization can find whether the
chosen field is attractive or not and assess its own position within the industry.

 Some of the techniques which are generally used for carrying out environmental analysis are:
1. PESTEL analysis
2. SWOT analysis

 
PESTEL-  PESTEL Analysis is a checklist to analyze the political, economic,
socio-cultural, technological, environmental and legal aspects of the
environment.

Political trends
Political considerations include developments not only in the conduct of local, regional, and foreign
governments and agencies but also in the thought and behavior of prominent organizations and
individuals: in many ways, government policies and regulatory decisions influence competition. Significant
uncertainty hangs over financial markets, for example, because of a potential trade war between the
United States and China.
 
Economic trends
Economic trends include resource and price use, interest rates, disposal income, employment, inflation,
and productivity. Emerging economies in China, India, and several other Asian countries have led the
world in economic growth rates since the 2008 financial crisis. Though globalization has slowed down in
the aftermath of the global financial crisis, it shows every sign of continuing, though at a slower pace.
 
Social trends
Social factors include changes in economic, social, and lifestyle, gender roles and group identities,
national cultures, ethics, morals, and aspirations. The post-WWII baby boom in Western countries created
a strong and distinct community of customers who will spend more on health and leisure as they age.
 
Technological trends
The technology involves impacts on personnel, organizational practices, goods and services, and
operations from current and emerging technological changes. The proliferation of smartphones and
applications for price scanning and the expanded usage of the Internet changes the nature of shopping
and the role of information more generally.
 
Environmental trends
Environmental factors include not only quality of life, sustainability, and resource recycling but also
logistical and infrastructure possibilities. Issues such as environmental wealth, global warming, and plastic
packaging waste and intensive farming escalate. Many companies would have to take these into account.
 
Legal trends
Legal considerations include legislation and administrative action, boundary requirements, standards, and
labor regulations. It can also include topics of globalization that deal with international trade and
competition law. National legal systems differ enormously, and their consequences are profound for
individual industries. One of the most significant  trends is to tighten regulatory accounting standards
after massive corporate failures – like Enron, Tyco International, Peregrine Systems, and WorldCom – and
the dot.com bubble burst.
 
 
The PESTEL process
The PESTEL process should be kept as simple as possible with the big picture always  kept central. The use
of the approach should follow this set of principles:
 
1. Someone should be in charge of the process, including meetings and discussions.
2. Before starting, think through the process and be clear what the objectives of the PESTEL analysis are.
3. Keep it simple; do not get bogged down in detail so that the big picture gets lost.
4. Involve a balance of pessimists and optimists; include outsiders with different perspectives and beware
of vested interests and groupthink.
5. Agree on appropriate sources and check inside the organization first for information.
6. Use visual tools and discussion aids.
7. Identify the most critical factor issues for strategy.
8. Produce a discussion document for broader circulation.
9. Use feedback and follow-up checks on actions and keep all PESTEL  participants informed on a follow-
up to encourage continual dialogue.
10. Decide which issues to monitor on an ongoing basis; link to existing in-house processes for
monitoring and reviewing change, especially for planning.
 
PESTEL is a valuable tool for testing and defining strategic goals, as managers are  encouraged to look
beyond their company and sector and be less insular. However, beware of  system vulnerabilities.
Scanning data can be too easy and slip into lazily ticking boxes over time. A strong 

PESTEL will go far enough to understand the root causes behind the trends; things are not always as it
seems. The research should not just emphasize the obvious; strategists should avoid overloading
information.