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Unit 3: Business environment


PESTEL analysis is a method that can be used to look at the environment within which all firms operate. It is a part of the external analysis when conducting a strategic analysis or doing market research and gives a certain overview of the different macro environmental factors that the company has to take into consideration. The initials stand for Political, Economic, Social, Technological, Ecological and Legal. Each of these areas has an effect on a business in one way or another. A business must recognize this and adapt its strategy accordingly. Firms that ignore external factors will lose sales to competitors that recognize them.

Political factors
How and what degree government intervenes in the economy. Some political factors include, as tax policy, government spending, trade restrictions, tariffs, government regulations and political stability of the country.

How it influence the businesses


Governments impose regulations on business that must be adhered to. These cover health and safety issues, consumer protection, advertising standards, employment conditions and environmental factors. These will increase the costs of business. Some of the government regulations would create new business opportunities as well. Governments also influence business through the tax system. Indirect taxes make the goods more expensive for the consumer while subsidies reduce the market price. Other influences include items such as planning permission, incentives for location or the promotion of exports.

Economic factors
Economic factors include economic growth, interest rates, exchange rate, inflation, unemployment, globalization, and overall economic stability of the economy. These factors have major impacts on how businesses operate and make decisions.

How it influence the businesses


The state of the economy is one of the most important influences. Most economies exhibit a trade cycle of growth followed by a slow down and possibly recession. This will affect the level of demand for the firms products. At the same time the firm will also be affected by changes in unemployment or interest rate changes. Growing unemployment will reduce demand while rising interest rates will increase business costs. The reverse is true for falling unemployment and cuts in interest rates. In a similar way changes in the exchange rate will affect the ability of firms to compete against foreign companies in their own markets and to be competitive abroad.

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Interest rates Interest rate is cost of borrowing money and the reward for saving it. Increase in interest rates increase the cost of borrowing; consumers have less money to spend as people will like to borrow less and save more. Difficult to raise the funds for expansion. As a result it will increase the overall cost of the business and hence making it difficult to compete and at the same time demand for goods and services will be reduced. The higher cost of borrowing will increase the risk involved in expanding production. Exchange rates Change Fall in exchange rate (Depreciation) Rise in exchange rate (Appreciation) Impact on Imports Imports more expensive consumers may switch to domestic goods Imports cheaper more competition for domestic producers Impact on Exports Exports appear cheaper to foreign buyers boost to export demand Exports dearer harder to sell in foreign market

The exchange rate is the price of one currency expressed in terms of another. If the exchange rate increases, the firm will have a difficult decision to make if its product has high foreign demand. The product will appear expensive abroad and possibly lead to a fall in sales. Such firms can reduce its prices and accept a lower profit margin. Corporate tax An increase in corporation tax will reduce net profit after tax and leave the company with fewer funds with which to fund the expansion and hence will increase the borrowings It will also mean that future profits from the proposed expansion will not now seem as attractive as the government will take a larger slice in taxation. Economic growth An increase in domestic growth should result in higher demand for its products and less need to target foreign markets However, growing demand may also affect the price of raw materials and labor resulting in higher costs Normally this is viewed as an opportunity Recession Recession is a period when economic growth is negative. The demand for the products will fall The business could adopt any of the following in times of recession:

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Reduce prices to retain current sales levels and market share. This will result in lower profit margins unless accompanied by cost cutting measures. Review the marketing strategy to target new and less affected markets, possibly in other countries. Reduce spending on product development and research and development. This will reduce cash outflow in the short run but might damage sales when the economy recovers. Downsize the business by shedding surplus or peripheral labor and closing less profitable branches. Recovery Overall demand begins to increase The firms could adopt any of the following during a recover Increasing output using the same labor force but working longer hours. Slowly increasing the labor force with the recruitment of part-time or casual labor in order to move towards full capacity The gradual replacement of old machinery with new investment in order to increase capacity while at the same time reducing unit costs Competition If the competition increases, consumers will have more choice of products. Firm will have to work harder to retain existing customers and to attract new ones In a period of high competition, firms could adopt any of the following strategies Review the marketing strategy to target new and less affected markets, possibly in other countries. Reduce prices to retain current sales levels and market share. This could result in a price war, as other competitors will lower their prices too. Increase spending on product development and research and development in order to develop new and more attractive products at the cutting edge of technology. This will be beneficial in long run. Increase spending on promotion to differentiate the products. Inflation An increase in general price level of an economy over a given period of time is referred as inflation. There are several methods used to measure the inflation, Consumer Price Index (CPI) being the most common method. There are two major types (causes) of inflation: Demand-pull inflation: Caused where there is excess demand for the available goods and services in the economy and firms are unable to satisfy the current level of demand where by this excess demand pulling the prices up. Cost-push inflation: Causes due to increase in the prices of factors of production.

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There are several problems associated with high inflation: Rising prices causes worsening poverty as the essentials for survival become more expensive and thus less attainable to those with low incomes. Rising prices creates uncertainty. In a climate of uncertainty both domestic and foreign entrepreneurs will be reluctant to invest. This will slow down the potential for economic growth. During high inflation, borrowers will gain and lenders will lose.

Unemployment Unemployment refers to the amount of joblessness in the economy. A person is generally unemployed if they are willing and able to work, but cannot find employment. The major three types of unemployment are: Frictional: Caused by workers moving between jobs. This is temporary form of unemployment. Structural: Caused by structural change in the economy, leading often to a change in skills required. Cyclical: Caused by the fall in aggregate demand. Consequences of unemployment could include: Adverse social effects social blight Greater divisions within society Higher governmental costs Loss of potential for maintaining or increasing national output and income Loss of work skills and experience More difficult for business to maintain their planned level of sales and can have a negative effect on profits and cash flow

Government policies to control unemployment could include: Job creation schemes, grant assistance, incentives Labor mobility schemes

Socio Cultural factors


Include the cultural aspects and include health consciousness, population growth rate, age distribution, career attitudes and emphasis on safety. Trends in social factors affect the demand for a company's products and how that company operates.

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How it influence the businesses


A business must be aware of changes in society. Demographic changes will affect demand in different sectors. The ageing population in Europe has led to greater demands for healthcare, leisure activities and nursing homes for elderly. Similarly an economy with an expanding, younger population will experience rising demand for childrens clothes, childcare facilities and schools. As societies grow wealthier the population spends a greater proportion on leisure pursuits such as foreign holidays, sports and pastimes. Changes in public attitudes can also affect a business. The public are more environmentally aware and are not prepared to buy products and services that are considered antisocial, e.g. aerosols that contain CFCs. Consumer opinion has forced firms to abandon trade involving endangered species and the production of goods that leads to the destruction of the rain forests. Failure to recognize change and to adapt can lead to the decline and eventual closure of a business.

Technological factors
Technology can influence many aspects of the organization such as marketing and distribution, structure, production methods, communication, and purchasing. They can determine barriers to entry, minimum efficient production level and influence outsourcing decisions.

How it influence the businesses


Technological changes affect not only the production process but also the range of products that is possible. The microchip has led to the miniaturization of many products while the development of plastics has revolutionized the style of products and their cost. The leisure industry has witnessed vast changes with the advent of computer games and miniaturized music systems. The quality of items has also been affected. In agriculture science has developed disease resistant plants, improved crop yields and created new hybrid specimens. A business must be aware of changes otherwise it will lose market share to competitors that are more technologically advanced.

Impact of Information and communication technology (ICT) in business


The use of computers in business has had a major impact on the recording, storing, analysis and retrieving of information. Everything from stock records to customer details can be accessed at the touch of a button. This saves time and allows the data to be manipulated, for example building customer profiles for advertising campaigns. Use of bar codes enables stock to be recorded quickly, efficiently and accurately. At sales tills, items can be scanned by laser readers, making the servicing of customers quicker and more accurate. At the same time, stock details are automatically updated.

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Software packages now exist to help design products and to automatically control machinery. This is known as CADCAM, computer aided design and computer aided manufacture. This allows firms to shorten the time between conception of a product to delivery to the market Mobile phone technology is another area that has had a significant impact on businesses. The use of mobile phones has allowed key employees to be contactable even in remote areas. E-mails and faxes can be downloaded to a laptop computer through a mobile phone via a satellite link. Information is now available instantly and queries can be sorted with less delay. Internet retailing and the growth of computer-based games. Advantages of IT in business One major advance in Information Technology has been the increased use of robotics in high-speed, fully automated flow production systems, e.g. in car assembly plants. This has resulted in higher productivity, increased quality and lower unit costs. These advantages have lead to lower consumer prices. The use of laser scanners in supermarkets has increased the speed and accuracy of the checkout operation as well as allowing immediate updates of stock levels and re-ordering. Disadvantages of IT in business Technology has replaced the need for a lot of unskilled and semiskilled labor. Those affected have suffered long-term unemployment unless they were fortunate enough to retrain Advances in science can cause some products to be made redundant. For example, the development of computers for office work has replaced the need for typewriters.

Ecological/Environmental factors
Include weather, climate, and climate change, which may especially affect industries such as tourism, farming, and insurance. Growing awareness to climate change is affecting how companies operate and the products they offer--it is both creating new markets and diminishing or destroying existing ones.

Effects of environmental awareness among customers


A company must acknowledge the opinions of its customers or risk losing their support. Business must ensure that its practices are not contrary to current public opinion. Issuing written environmental policy to address issues involving the firm. Firm could use its environmentally friendly approach to win new customers by advertising the positive points. Highlight the lack of damage to the planet in its production process, its products and in its exploitation of resources.

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A business producing in a developing country might emphasize its contribution to the local economy, its training of the work force or the building of social infrastructure such as schools and hospitals. The firm could seize the opportunity to create new environmentally friendly products for the market. E.g. Body Shop

Legal factors
Include discrimination law, consumer law, antitrust law, employment law, and health and safety law. These factors can affect how a company operates, its costs, and the demand for its products. Businesses have to do, to make sure they are not breaking the law. Laws against unfair discrimination at work and when applying for jobs. There is no unfair discrimination on the basis of Race, religion, sex, age, or color. There are laws for health and Safety at work, protecting employees against unfair dismissal and ensuring fair wages to employees. Government legislations would normally increase the cost of the operation for many businesses.

Ethics
Ethics is the science of right and wrong. It is the branch of philosophy dealing with values relating to human conduct, with respect to the rightness and wrongness of certain actions and to the goodness and badness of the motives and ends of such actions Why ethics is important As ethical issues become more important to society in general, and an organizations customer in particular; organizations need to recognize the value of ethics. An organization failing to appreciate the importance of ethical issues will be out synch with its customers. Ethical trading (or ethical consumerism) The production and purchasing of items that are made ethically. Generally, this means without harm to, or exploitation of, humans, animals or the natural environment. From a consumers perspective this can take on the following forms: Positive buying - favoring ethical products, and businesses that operate on principles based primarily on benefit for the greater good rather than self-interest. This would include only buying from firms that paid fair wages, used recycled materials and kept pollution to a minimum. Moral boycott - this is negative purchasing, i.e. not buying from certain companies because they have a poor environmental or ethical reputation.

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Using PEST analysis, show how external factors can influence a business? A business can be influenced by political, economic, social and technological factors. These are external factors over which a firm has no control. The business must, however, recognize these changes and adapt accordingly. The economic climate can greatly affect a business. In a recession the general level of demand falls which will limit the ability of the firm to sell its goods at their full price. In the UK the recession of the early 1990s resulted in around 62,000 firms closing in a single year. Another economic factor is the amount of competition and the behavior adopted by competitors. A firm making a similar product may adopt a price cutting policy. This will demand a response from all other firms, otherwise they may lose market share. In a similar way a business must also be aware of changes in consumer taste. New products entering the market can quickly erode sales and in some cases make a product redundant. For example, in the music market the vinyl record has been largely replaced by the cassette and increasingly by compact disks. The government also has a great influence on business activity. In the first place it dictates a legal framework within which the business must operate. Laws regarding health and safety, labeling and packaging and the protection of the consumer all add costs on to the product. Governments also influence businesses through their taxation policy. Indirect taxes on goods and services have the effect of raising prices. Direct taxes are levied on company profits. Changes in taxation therefore can affect a firms market and the level of reward that can be earned for the risks taken in business. Technological changes can be the most significant external factor. New products, new methods of manufacture and new materials can be developed which may change the market completely. Many products are now made from hardened plastic rather than wood or steel. The use of the microchip has revolutionized certain industries enabling customers to have mobile phones and mobile music players (iPods, MP3 players etc). The car industry makes full use of robotics in order to eliminate the need for labor and to ensure a higher quality product. Changes like these affect a firms market and each business must adapt to the opportunities or be left behind by more progressive firms. Finally the business is affected by changes in society. Where the population is ageing the pattern of demand will alter. There will be a greater emphasis on the provision of health care and leisure activities for the elderly. Similarly an economy with an expanding, younger population will experience rising demand for childrens clothes, childcare facilities and schools. As well as demographic changes there may be alterations in societys attitudes. Many people are now more environmentally friendly and want products and firms to reflect this. Consumer opinion has forced firms to abandon trade involving endangered species and the production of goods that leads to the destruction of the rainforests. Failure to recognize change and to adapt can lead to the decline and eventual closure of a business.