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Need, Characteristics, and Categorization of Environmental Factors

Environmental Analysis is described as the process which examines all the components, internal or external, that has an influence on the performance of the organization. The internal components indicate the strengths and weakness of the business entity whereas the external components represent the opportunities and threats outside the organization.

To perform environmental analysis, a constant stream of relevant information is required to find out the best course of action. Strategic Planners use the information gathered from the environmental analysis for forecasting trends for future in advance. The information can also be used to assess operating environment and set up organizational goals.

It ascertains whether the goals defined by the organization are achievable or not, with the present strategies. If is not possible to reach those goals with the existing strategies, then new strategies are devised or old ones are modified accordingly.

Advantages of Environmental Analysis

The internal insights provided by the environmental analysis are used to assess employee’s performance, customer satisfaction, maintenance cost, etc. to take corrective action wherever required. Further, the external metrics help in responding to the environment in a positive manner and also aligning the strategies according to the objectives of the organization.

Environmental analysis helps in the detection of threats at an early stage, that assist the organization in developing strategies for its survival. Add to that, it identifies opportunities, such as prospective customers, new product, segment and technology, to occupy a maximum share of the market than its competitors.

Steps Involved in Environmental Analysis

  1. Identifying: First of all, the factors which influence the business entity are to be identified, to improve its position in the market. The identification is performed at various levels, i.e. company level, market level, national level and global level.
  2. Scanning: Scanning implies the process of critically examining the factors that highly influence the business, as all the factors identified in the previous step effects the entity with the same intensity. Once the important factors are identified, strategies can be made for its improvement.
  3. Analysing: In this step, a careful analysis of all the environmental factors is made to determine their effect on different business levels and on the business as a whole. Different tools available for the analysis include benchmarking, Delphi technique and scenario building.
  4. Forecasting: After identification, examination and analysis, lastly the impact of the variables is to be forecasted.

Environmental analysis is an ongoing process and follows a holistic approach, that continuously scans the forces effecting the business environment and covers 360 degrees of the horizon, rather than a specificsegment.

Internal Environment:

Survival of a business depends upon its strengths and adaptability to the environment. The internal strengths represent its internal environment. It consists of financial, physical, human and technological resources. Financial resources represent financial strength of the company. Funds are allocated over activities that maximise output at minimum cost, that is, optimum allocation of financial resources.

Physical resources represent physical assets such as plant, machinery, building etc. that convert inputs into outputs. Human resources represent the manpower with specialised knowledge that performs the business activities.

The operative and managerial decisions are taken by the human resources. Technological resources represent the technical know-how used to manufacture goods and services. Internal environment consists of controllable factors that can be modified according to needs of the external environment.

External Environment:

The external environment consists of legal, political, socio-cultural, demographic factors etc. These are uncontrollable factors and firms adapt to this environment. They adjust internal environment with the external environment to take advantage of the environmental opportunities and strive against environmental threats. Business decisions are affected by both internal and external environment.

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The external environment consists of the micro environment and macro environment

1. Micro Environment:

“The micro environment consists of factors in the company’s immediate environment”. These factors affect the performance of a company and its ability to serve the customers. Micro environment consists of customers, suppliers, competitors, public and market intermediaries.

A brief discussion of the firm’s micro environment is as follows:

(i) Customers:

Customers constitute important segment of the micro environment. Business exists to serve its customers. Unless there are customers, business has no meaning. A company can have different types of customers like, households, producers, retailers, Government and foreign buyers.

(ii) Suppliers:

They supply inputs (money, raw material, fuel, power and other factors of production) and help in smooth conduct of the business. Firms should remain aware of the policies of suppliers as increase in prices of inputs will affect their sales and profits. Shortage of supplies also affects the production schedules. Firms should have more than one supplier so that change in policies of one supplier does not affect their production schedules.

(iii) Competitors:

Competitors form important part of the micro environment. Firms compete to capture big share of the market. They constantly watch competitors’ policies and adjust their policies to gain customer confidence.

(iv) Public:

“A public is any group that has an actual or potential interest in or impact on an organisation’s ability to achieve its interest”. Public can promote or demote company’s efforts to serve the market. The term ‘public’ consists of financial public (banks, financial institutions etc.), media public (newspapers, radio, television etc.), Government public, customer organisations, internal public (workers and managers), local public (neighbourhood or community residents) and general public (buyers at large). Companies observe the behaviour of these groups to make functional policies.

(v) Market intermediaries:

They are the links that help to promote, sell and distribute the products to final consumers. They are the physical distribution firms (transport firm), service agencies (media firms), financial intermediaries (banks, insurance companies) etc. that help in producing, marketing and insuring the goods against loss of theft, fire etc. Firms maintain good relations with them to carry their activities smoothly. All these factors are largely controllable by the firms but they operate in the larger macro environment beyond their control.

2. Macro Environment:

The macro environment consists of the economic and non- economic variables that provide opportunities and threats to firms. This is largely uncontrollable and, therefore, firms adjust their operations to these environmental factors.

The macro-environment consists of the following:

(a) Economic Environment:

The economic environment consists of economic forces that affect business activities. Industrial production, agriculture, infrastructure, national income, per capita income, money supply, price level, monetary and fiscal policies, population, business cycles, economic policies, infrastructural facilities, financial facilities etc. constitute the economic environment.

The economic environment influences the activities of business enterprises. In the capitalist economies, firms have the freedom to choose the occupation. The economic decisions to invest, produce and sell are guided by profit motives. The factors of production are privately owned and production activities are initiated by the private entrepreneurs.

In socialist economies, these decisions are taken by the public sector which is guided more by social welfare than profit maximisation. The economy is controlled by the central master plan prepared by the State. In a mixed economy, public and private sectors co-exist and singly or jointly own the factors of production.

Scarce economic resources are allocated over various business activities. Decisions regarding allocation of resources which respect to what to produce, how to produce and for whom to produce; nature of technology and the techniques of production, timing of production etc. differ in different economies. This constitutes economic environment of the economy.

The economic environment affects business in the following ways:

(i) Complete capitalisation or socialism does not exist. Free market economy and centralised planning exist together, though in varying degrees. In the world of liberalisation and globalisation, state planning is combined with free pricing to make macro-economic decisions for business entrepreneurs and welfare of society.

“The economy in which a business operates is not exclusively a free enterprise economy using prices and markets, but to some extent directed or in-directed by a system of planning, control, regulation and coordination.”

(ii) State controls the economy (or the business enterprises) through planning and regulation. It enforces upon business enterprises the responsibility of social responsiveness (responsibility towards society) by welfare-state principles enacted through legislation that enforce minimum wages, commodity control, fair trade practices etc. Legislative machinery promotes economic growth, efficiency and equity. Social responsibility is the outcome of business interaction with economic environment.

(iii) Some business firms are positively affected by the Government policy while others are negatively affected. A restrictive import policy, for example, protects home industries but liberal import policy can harm the domestic industries.

(iv) The incentives and disincentives provided by the Government affect business enterprises in many ways. To enjoy the economies of scale, firms establish the business in large cities but the Government promotes them to establish their units in backward areas by providing various tax incentives. The economic environment of a country, thus, removes regional disparities and promotes equitable growth of the economy.

(v) By providing incentives in the priority sector that produce essential goods for the economy, the Government promotes industrial sector of the economy.

(vi) Modern economies are open systems. The economic environment of one country affects the economic environment of another country. Multinational corporations operate world-wide and provide a number of benefits to host countries and home countries. This has developed science and technology and unified the world economy.

The economic system helps in answering questions like:

  1. Is it the right time to set up the business?
  2. Can new products be added to the product line?
  3. Is the market size large enough to provide desired rate of returns?
  4. Is the environment conducive in terms of availability of manpower, infrastructure, raw material, finance, building, plant and machinery etc.?

The economic environment, thus, plays vital role in shaping the culture of the economy. Market forces and State planning provide the constraints within which business enterprises carry out their functions. “Progressive management must keep itself continuously informed about the magnitude and direction of changes in national as well as international economic environment.”

(b) Non-Economic Environment:

It consists of socio-cultural, demographic, natural, physical, technological, political and legal environment that influence and are influenced by the economic environment. A large number of variables affect the non-economic environment.

Some of the important areas of non-economic environment are discussed below:

(i) Political-legal environment:

It is the legislative, executive and judicial environment of the country that shapes and controls business activities. The legislature describes the laws and courses of action to be followed by firms, the executive implements the decisions taken by the legislature (Parliament) and the judiciary ensures that legislature and executive function in the interest of the society. A stable political environment is conducive to business growth.

A business operates in the environment of Government regulations. Various laws are made to regulate the functions of business enterprises. They relate to standards of product, packaging of products, protection of environmental and ecological balance, ban on advertisement of certain products (liquor), advertisement of certain products with statutory warning (cigarette) etc.

There are laws to prevent restrictive trade practices and concentration of economic power in few hands. Regulations promote entry of firms in backward areas and products are reserved for small-scale sector. Liberalisation policies have allowed the Indian industries to operate in international markets and foreign companies to operate in Indian markets. This allows growth and diversification of markets and access to advanced science and technology for Indian entrepreneurs. At the same time, it threatens the small Indian companies that cannot compete with large foreign companies.

The political-legal environment provides a host of laws and regulations that affect the business affairs. It provides opportunities, threats and challenges for the business enterprises. The Government interacts with business enterprises at the local level, State level and the Central level and regulates their functions through various rulings.

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