Describe and Analyse the External Environment of Business

The external environment is the “external context within which an organisation exists and operates.”1 One of the ways in which the external environment can be analysed is by assessing the impact of politics, the economy, social factors and technological factors (P.E.S.T. analysis).

The organisations are affected either generally or immediately by the external environment. The immediate factors, also referred to as the operational environment, include aspects such as suppliers, financial institutions, customers and labour markets.

The general features, or the contextual environment, comprise of the economic, political, legal and technological influences, for example.

The political environment has an affect on businesses because they can influence the market structure and behaviour. The market structure is the share of a market particular companies have. The government have a regulation that states that no company can gain a bigger market share than twenty five percent, other than through organic growth. They control taxation and are responsible for any international trading blocs, therefore restricting overseas trade.

The social environment has an impact on supply and demand. The amount of disposable income a person or group of people have influence sales and therefore play a big factor for companies. The demographics of a country affect this, as products have to be marketed and produced for specific consumers.

The success of a business is influenced by technology because the innovation and investment of new technology increase competition because efficiency is usually increased.

The economic environment is affected by the government and can be viewed alongside one and other. Unemployment levels, inflation and interest rates are all part of the economical factors on business and are clearly also part of the political environment.

One of the main factors of the economy is inflation. Inflation is “a sustained rise in the average price of goods within an economy.”2 Inflation occurs usually through their being a bigger demand than supply of a good. This results in increased prices and this allows a firm to increase wages to attract the sources to meet the demand.

Inflation can act positively on a business because if they have taken out a substantial loan then it actually becomes easier to pay back because inflation has reduced the real value of the sum that is outstanding. This is because the firm is creating a much larger income than it normally would due to the increase in prices. So although sales may drop due to increased prices the profits are likely to still increase because of the demand for the good. The extra income they now have that had not been predicted because of their repayments on the loan, allows the firm to grow because they can use the unexpected capital to invest in new technology, and this would make them more efficient.

However there are many more negatives regarding inflation. Uncertainty is caused because firms cannot plan for their future effectively, because it is very difficult to predict the future of the economy when there is not a stable rate of inflation.

Consumers become price sensitive and the more brand loyal customers are likely to switch to a cheaper alternative. This affects the larger firms in the industry because they either have to lower their prices or increase advertising, which will both prove costly for them. However the smaller independent companies can benefit from customers becoming price sensitive because they will see sales increase, and if they can prove that their quality is good, when the economy becomes stable once again, the customers may choose to stay loyal to the cheaper product.

Another problem for businesses is that staff will become dissatisfied and less effective unless their wage increases at the same level of inflation because if it doesn’t their wage is effectively lowering because it does not carry the same value.

Inflation is a problem for sellers of a service or luxury goods because people have less disposable income. For example people would be more likely to stop buying organic goods and settle for the standard version.

The government has to control inflation because unemployment can be caused, because firms have to reduce costs and reducing staff is an easy way to do this and effective for luxury good companies because demand will be less so therefore they will not have to produce as much, hence not as many staff will be required. Unemployment therefore needs reducing because as ‘Phillips Curve’ suggests inflation is higher when unemployment is high.

International trade is affected because foreign countries will receive a less favourable exchange rate and they may therefore reduce trade with UK companies, which again affects their profits.

The government can use