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Q. How do we manage external and internal business environment?

Business and the environment

Business environment is a set of political, economic, social and technological (PEST)
forces that are largely outside the control and influence of a business and that can
potentially have both a positive and a negative impact on the business.

The business environment can be broadly divided into:

(A) External environment

(B) Internal environment

One of the basic assumptions of business is that organisations are neither self sufficient
nor self contained.Rather , they exchange resources with and are dependent upon the
external environment, defined as all the elements outside an organisation that are
relevant to its operations. Organisations take inputs (raw materials, money, labour, and
energy) from the external environment.

The many rapid changes taking place in the external environment of the organisations
require increasing attention from the managers. The external environment contains
numerous resources upon which the organisations rely. This means that the
organisations are inevitably affected by what goes on in the environment.

The external environment has both direct-action and indirect-action elements . The
External Analysis examines opportunities and threats that exist in the environment. Both
opportunities and threats exist independently of the firm. The way to differentiate
between a strength or weakness from an opportunity or threat is to ask: Would this issue
exist if the company did not exist? If the answer is yes, it should be considered external
to the firm. Opportunities refer to favorable conditions in the environment that could
produce rewards for the organization if acted upon properly. That is, opportunities are
situations that exist but must be acted on if the firm is to benefit from them. Threats
refer to conditions or barriers that may prevent the firms from reaching its objectives.
The following area analyses are used to look at all external factors affecting a

• Customer analysis: Segments, motivations, unmet needs

• Competitive analysis: Identify completely, put in strategic groups, evaluate performance,
image, their objectives, strategies, culture, cost structure, strengths, weakness
• Market analysis: Overall size, projected growth, profitability, entry barriers, cost
structure, distribution system, trends, key success factors
• Environmental analysis: Technological, governmental, economic, cultural, demographic,
scenarios, information-need areas.
Goal: To identify external opportunities, threats, trends, and strategic uncertainties.
External environment can be categorized into :
I. Micro environment or direct action environment

It involves individuals or organisations that a firm deals with on a regular basis. For example,
suppliers, distributors, competitors, customers and employees are all members of the micro-
environment. These groups are stakeholders of the business. They all have a direct interest in the
activities of the firm and are clearly affected by its actions. The micro environment therefore plays
a critical role in the success and behaviour of a business.
Micro environment can be further divided into:

(a) External stakeholders

• SUPPLIERS: Organisations are dependent upon suppliers of materials and labour and will
try to take advantage of competition among suppliers to obtain lower prices, better-
quality work, and faster deliveries. Every organisation buys inputs-raw materials, services,
energy, equipment and labour from the environment and uses them to produce output.
Organizations are therefore dependent upon suppliers of materials and labour and will try
to take advantage of competition among suppliers to obtain lower prices, better quality
work, and faster deliveries. Some firms take quite an aggressive attitude towards their
suppliers by trying to push down the prices and delay payments. Others view the
relationship more as a partnership in which they are working together with suppliers and
that by helping each other both can benefit.
• COMPETITORS: The success and behaviour of any business will depend on the degree of
competition in its market. In some markets one firm is dominant. This is called a
monopoly. In other markets a few firms dominate; this type of market structure is called
an oligopoly. In oligopolistic markets there is a high degree of interdependence and so
firms will think carefully how their rivals might react to any actions they take. This can
lead to an emphasis on non price competition; a price change is relatively easy to imitate
and so firms may rely more on methods such as branding or product development.
A business could react to an increase in competition (e.g. a launch of rival product) in the
following ways:

• Cut prices

• Improve quality

• Spend more on promotion Cut costs, e.g. use cheaper materials, make some workers

 CUSTOMERS: Customers are obviously the key to sales. Usually, a marketing manager
analyses the potential customers and market conditions and directs a marketing
campaign based on that analysis. Managers must monitor customer needs and try to
anticipate how these will develop so that they can meet these requirements effectively
now and in the future. To help understand their customers firms are increasingly trying to
gather information on them through mechanisms such as loyalty cards. By gathering data
on shopping patterns and matching this to data the individual shoppers firms can build up
detailed pictures of their buyers and then offer them appropriate deals.
 SPECIAL INTERST GROUPS: They are groups of people who organise to use the political
process to advance their position on particular issues, such as abortion and gun control.
Managers must take both the present and future SIGs into account when setting
organisational strategy. Among the most important SIGs are consumer advocates and
 MEDIA: Today, managers at most large organisations realise they operate in a fishbowl
where every action may be the subject of media scrutiny. To improve their communication
with both internal and external audiences, they have developed sophisticated public
relations and marketing departments. In addition, executives who regularly deal with
media often seek professional coaching to improve their ability to present information and
opinions clearly and effectively.
 FINANCIAL INSTITUTIONS: Both new and well establishes organisations may rely on
short term or long term loans. Because effective working relationships with financial
institutions are so vitally important, establishing and maintaining such relationships is
normally the joint responsibility of the chief financial officer and the chief operating officer
of the organisation.
• DISTRIBUTORS: Often getting products to the end customers can be a major issue for
firms. Imagine you sell shampoo - what you need to sell this is to get it on the shelves in
the leading chemists and supermarkets but this means moving someone else's products
off the shelves! So the challenge is to get stores to stock your products; this may be
achieved by good negotiating skills and offering appropriate incentives. When selling via
retailers, for example, the retailer has control over where the products are displayed and
how much they are promoted in-store. Banks, insurance companies, holiday firms, hotels
and many others businesses have seen the opportunities created by the internet. Direct
Line insurance, Dell computers and Amazon have reduced costs by selling direct.
• GOVERNMENT: Economic policies affect firms’ costs (through taxation and interest
rates).Legislation formulated by the govt. regulates what business can do in areas such as
the environment and occupational safety and health. Successful firms are good for
governments as they create wealth and employment.

(a)Internal stakeholders
 EMPLOYEES: A business needs staff or employees to carry out its activities
Employees agree to work a certain number of hours in return for a wage or salary
Pay levels vary with skills, qualifications, age, location, types of work and industry
and other factors

• SHAREHOLDERS AND BOARD OF DIRECTORS: The number of owners and the roles
they carry out differ according to the size of the firm. In small businesses there may be
only one owner (sole trader) or perhaps a small number of partners (partnership).In large
firms there are often thousands of shareholders, who each own a small part of the

This involves factors outside of the direct control of the business. These macro-factors
such as the economy, government policy and social change can have a significant effect
on a firm's success but the relationship is fairly one way. The macro-environment can be
analysed using PESTEL analysis.
A PEST analysis is one of them that is merely a framework that categorizes environmental
influences as political, economic, social and technological forces. Sometimes two
additional factors, environmental and legal, will be added to make a PESTEL analysis, but
these themes can easily be subsumed in the others. The analysis examines the impact of
each of these factors (and their interplay with each other) on the business. The results can
then be used to take advantage of opportunities and to make contingency plans for
threats when preparing business and strategic plans

The classification distinguishes between:

• Political factors. These refer to government policy such as the degree of intervention in
the economy. What goods and services does a government want to provide? To what
extent does it believe in subsidising firms? What are its priorities in terms of business
support? Political decisions can impact on many vital areas for business such as the
education of the workforce, the health of the nation and the quality of the infrastructure of
the economy such as the road and rail system.
• Economic factors: These include interest rates, taxation changes, economic growth,
inflation and exchange rates. For example:
- higher interest rates may deter investment because it costs more to borrow
- a strong currency may make exporting more difficult because it may raise the price in
terms of foreign currency
- inflation may provoke higher wage demands from employees and raise costs
- higher national income growth may boost demand for a firm's products.
• Social factors: Changes in social trends can impact on the demand for a firm's products
and the availability and willingness of individuals to work. There are basically three types
of social factors: Demographic (size, structure & distribution of population), social and
• Technological factors: New technologies create new products and new processes. MP3
players, computer games, online gambling and high definition TVs are all new markets
created by technological advances. Online shopping, bar coding and computer aided
design are all improvements to the way we do business as a result of better technology.
Technology can reduce costs, improve quality and lead to innovation. These
developments can benefit consumers as well as the organisations providing the products.
• Environmental factors: Environmental factors include the weather and climate change.
With major climate changes occurring due to global warming and with greater
environmental awareness; the growing desire to protect the environment is having an
impact on many industries such as the travel and transportation industries (for example,
more taxes being placed on air travel and the success of hybrid cars) and the general
move towards more environmentally friendly products and processes is affecting demand
patterns and creating business opportunities.
• Legal factors: these are related to the legal environment in which firms operate. Legal
changes can affect a firm's costs (e.g. if new systems and procedures have to be
developed) and demand (e.g. if the law affects the likelihood of customers buying the
good or using the service).
Different categories of law include:
• Consumer laws
• Competition laws
• Employment laws
• Health and Safety legislation

Factor Often Comprised Of

Political - Current taxation policy
- Future taxation policy
- The current and future political support
- Effect of wars or worsening relations with particular

Economic - Overall economic situation

- Strength of consumer spending
- Current and future levels of government spending
- Ease of access to loans

Sociological - Demographics
- Lifestyle patterns and changes
- Attitudes towards issues such as education,
corporate responsibility and the environment
- Social mobility
- Media views and perceptions
- Ethnic and religious differences

Technological - Relevant current and future technology innovations

- The level of research funding
- The ways in which consumers make purchases
- Intellectual property rights and copyright
- Global communication technological advances

Legal - Legislation in areas such as employment,

competition and health & safety
- Future legislation changes
- Changes in European law
- Trading policies
- Regulatory bodies

Environmental - The level of pollution created by the product or

- Recycling considerations
- Attitudes to the environment from the government,
media and consumers
- Current and future environmental legislative

What managers need to do is to think about which factors are most

likely to change and which ones will have the greatest impact on them
i.e. each firm must identify the key factors in their own environment.
For some such as pharmaceutical companies government regulation may be
critical; for others, perhaps firms that have borrowed heavily, interest rate
changes may be a huge issue. Managers must decide on the relative
importance of various factors and one way of doing this is to rank or
score the likelihood of a change occurring and also rate the impact if it
did. The higher the likelihood of a change occurring and the greater the
impact of any change the more significant this factor will be to the
firm's planning.

Another version of PESTEL analysis is called LoNGPESTEL. This is illustrated

POLITICAL Provision of Government policy World trade
services by local on subsidies agreements e.g.
council Free Trade
ECONOMIC Local income Interest rates Overseas economic
SOCIAL Local population Demographic Migration flows
growth change (e.g. ageing
TECHNOLOGICAL Improvements in Country wide International
local technologies technology e.g. technological
e.g. availability of online services breakthroughs e.g.
Digital TV internet
ENVIRONMENTAL Local waste issues Weather Global climate
LEGAL Local Law International
licences/planning agreements on
permission human rights or
These can be incredibly important factors in a firm's macro-environment. The
growth of China and India, for example, have had massive effects on many
organisations. Firms can relocate production there to benefit from lower costs;
these emerging markets are also providing enormous markets for firms to aim
their products at. With a population of over 1 billion, for example, the Chinese
market is not one you would want to ignore; at the same time Chinese producers
should not be ignored either.

Whether a particular change is an opportunity or threat depends on the

specific position of a business- is it able to exploit the opportunities
created? Has it anticipated the change already and prepared for it or
has it been taken by surprise? Does it have the skills and resources
required to meet changing customer needs?
When considering the external changes that may occur and deciding whether
they are significant opportunities or threats managers must consider the internal
functions of their business. This is called SWOT analysis.
Influencing the PESTEL environment
For most firms there is little hope of influencing the PESTEL environment on their
own, at least on a global scale. It may be more feasible through industry
associations that are formed to protect their interests and represent a particular
sector such as cars or printing. These bodies represent many firms and therefore
may have more power than any individual firm when it comes to influencing
The organization’s resources, its capabilities and competencies make up the
internal environment of the organization. The internal environment plays a
crucial role in the strategic management process of the organization. It is a
direct reflection of what the organization can do in the event of a business-
related exigency. The organization’s core competencies help sustain it in the
long run in the face of competition. The paper discusses the factors, processes
and tools in the analysis of the internal environment of the organization. In this
context, the paper also examines the issue of core competency.


A SWOT analysis should be conducted after the PESTLE analysis, as the external
environment impacts on the strengths, weaknesses, opportunities and threats
that the business faces.

Analyse each aspect of the SWOT analysis and look at avenues which exploit the
strengths of the business and pursue the identified opportunities. Similarly, the
threats and weaknesses should be assessed and possible options identified so as
to minimise these. These options may include diversification, targeting a
different customer segment, or product development.
Strengths Weaknesses

What’s different about your business? What do your competitors have that
What do you do well? you don’t?
What unique resources or knowledge What areas can you improve at?
do you have? W
hat weaknesses do people perceive you
Think from an internal and external as having?
perspective. For example, if all your
competitors have a high quality Perception is just as important as the
product then having a high quality reality here. Do customers perceive
product is not a strength, it’s a you as having certain weaknesses?
necessity. Where do you think you could do
Opportunities Threats

What trends present an opportunity What legal and technological

to you? developments could threaten your
Are there any complementary business?
products which you could look to Are any new entrants likely?
expand into? What does your competition plan to
Are there any potentially beneficial do?
technological or legal developments?
Threats may often arise as a result of
Refer back to your strengths and your weaknesses. Assessing your
look at whether you can exploit any weaknesses will help you identify
opportunities through using them. future threats and assess how to
minimise them.

A strategy may be developed by using a firm's strengths to exploit the

opportunities that exist. For example, a strong brand name may be used to
extend a firm's products into new markets. It may also use these strengths to
protect itself against threats; for example, a retailer may use its finance to
acquire key locations to prevent a competitor buying them.
A firm may also want to protect itself against its weaknesses.
Undertaking a SWOT analysis effectively involves two things.
Firstly, managers have to correctly identify what all the relevant factors are
and how important each one is.
Secondly, managers need to work out the most appropriate strategy that
combines the strengths and opportunities and actually implement the plan
The importance of strategy should not be underestimated. The strategy sets out
where and how the battles will be fought and a good strategy is essential to
business success. This involves an understanding not only of what happens
within the firm but also the ability to forecast changes in the external
environment and their significance successfully.
As the internal and external environments change so must a firm's strategy to
maintain an appropriate fit.
Managers must ensure the complexity of the environment and rate of
environmental change. Environmental complexities deals with the
number and possible impacts of different forces in the environment

• Manager s should pay more attention to forces with larger impact

• Usually , the larger the organization, the greater is the number of forces
managers must oversee.
The more forces, the more complex the manager’s job becomes.


Managers can counter environmental threats by reducing the number of
forces. Many firms have sought to reduce it deals with which reduce
uncertainty. All levels managers should work to minimize the potential
impact of environmental forces .
Example: reduction of waste by first line managers , determining
competitor’s moves by middle managers , or the creation of a new
strategy by top managers.

Managers can create new organizational structure to deal with change.
Many firms use specific departments to respond to each force. Managers
also create mechanistic or organic structures. Mechanistic structures have
centralized authority :
1. Roles are clearly specified
2. Good for slowly changing environments
Organic structures authority is decentralized. Roles overlap,
providing quick response to change.

Managers must gain access to information needed to forecast future
issues. Rod Canion’s forecast of Compaq’s future was wrong due to his
incorrect view of the environment. Boundary spanning is the practice of
relating people outside the organization.
1. Seek ways to respond and influence stakeholder perception.
2. By gaining information outside, managers can make better decisions
about change.

More management levels involved in spanning, yields better overall

decision making


Environmental scanning is an important boundary spanning activity.
Includes reading journals, attending trade shows and the like.

Gatekeeping: the boundary spanner decides what information to allow

into organization and what to keep out. The manager must ensure that he
should not let bias decide what comes in.

Interorganisational relations: firms need alliances globally to best

utilize resources. Managers can become agents of change and have an
impact on the environment.