Paper: 08, International Business Operations

Module: 04, International Business Environment: External Environment -1

EEeEnvironment

Prof. S P Bansal
Principal Investigator Vice Chancellor
Maharaja Agrasen University, Baddi

Prof YoginderVerma
Co-Principal Investigator Pro–Vice Chancellor
Central University of Himachal Pradesh. Kangra. H.P.

Dr Shafali Nagpal
Paper Coordinator Human Resource Development Centre
BPSMV, KhanpurKalan, Sonipat

Dr Shafali Nagpal
Content Writer Human Resource Development Centre
BPSMV, KhanpurKalan, Sonipat
Items Description of Module
Subject Name Management
Paper Name International Business Operations
Module Title International Business Environment: External Environment
Module Id Module no.-04
Pre- Requisites Geographical, Demographic, Economic Factors
Objectives To study the basic concepts of external Factors effecting International Business
Keywords Geographical, Demographic, Economic Environment

QUADRANT-I

Module 11: International Economic Institutions

1. Learning Outcome
2. Introduction
3. Geographic environment
4. Demographic factors
5. Economic Environment
6. Changes in World Economy
7. Summary

Learning Outcome:
After completing this module the students will be able to:
• To understand various components of external business environment faced by global
companies.
• To know about geographic, demographic, economic components of the environment.

Introduction

In addition to the internal environment, which influences a firm’s operations and

performance, there are external factors as well, which influence the firms. The
external environmental components have a remote, but strong influence upon a firm.
Being external, these factors are not within the direct control of a firm and are also
called as ‘uncontrollable’ factors. Some of the components of the external
environment are:
a) Geographic environment
b) Demographic environment
c) Economic environment
d) Cultural environment
e) Political environment
f) Legal and regulatory environment
The following discussion explains the first three external environmental components
– geographic, demographic and economic. The next three environmental
components are explained in the next module.

A. Geographic Environment
The geographical environment comprises of various geographical factors that
surrounds a firm. The business firms operate in one or more geographical areas and
the geographical characteristics of that place assert a direct influence on the firm.
The geographical factors comprise of the physical features of the terrain and the
climate, which have a lot of influence upon other environmental aspects. The
geographical areas vary in terms of the physical features. Some areas are plains,
while others are hilly, or deserts. Some areas might be located on river banks, lakes,
seas, etc. The soil of some areas might be fertile, while other areas might by rocky
and sandy. Some areas might face lot of climatic hazards, for example the
hurricanes, earthquakes, extreme weather conditions, heavy rainfall, floods,
snowfall, or intense heat. Some areas might have many seasons, while the climate
in some areas might be moderate and pleasant. Some of the resulting impacts of
these geographic features are:
a) Population density
b) Accessibility
c) Consumption habits
d) Economic development

a) Population density :
The population density depends upon the geographic conditions of a place. People
like to live in the areas where the geographic and climatic conditions are favourable.
The human population has grown around river beds, coastal areas, fertile plains and
valleys. The density of population is very low in the rough terrains, deserts, snow
bound areas, areas with dense forests, etc. The business needs people for
consumption. Hence, the firms prefer to be located where there is more population
as the business operations are far more easy in those areas. We see most of the
investment coming in big cities, which are getting bigger because of population
migration. Industrial clusters and investments come around the areas with sizable
population. The population will determine the size of the market and hence its
potential and the firms must choose the countries and the geographical areas,
accordingly.
b) Accessibility
The geographic characteristics of an area influence the accessibility and the
development of means of transport. In the ancient times, the population grew around
the rivers and seas because of the easy transportation. The areas located in rugged
terrains would have limited accessibility and the cost of transportation in these areas
would be very high. For example, in hilly areas, the cost of transportation of building
material is so high that it almost doubles the cost of construction. Similarly, areas
with favourable physical features would be easily accessible, often located on well
developed roads, rail or waterway transportation facilities. The accessibility also
influences the population density and the firms need to take them into consideration
as well.
c) Consumption
The consumption patterns of the population are highly influenced by the areas in
which they live. The prevailing climatic conditions will decide the type of houses in
which they will live in. The building material, the design and the type of houses will
vary. Most plains would have flat roofed houses, multiple or group houses and very
dense population would be living in small areas. In the hilly areas, the houses would
be made of wood and they would be located in far off areas. Similarly, the
requirements of energy for heating, or air conditioning of the houses would influence
the cost of living.
The people’s clothes would depend upon the area in which they are living. The
people living in hot areas would prefer light clothing, while those living in the cold
areas would prefer the woollen clothing, which could be costlier. The firms will have
to design their garments depending upon the markets in which they are selling the
products. The areas with more seasons would create more demand for a wide range
of products, while the areas with more or less similar climatic conditions would create
lesser needs as the clothes and other requirements would not need much
replacement.
Peoples’ food is highly dependent upon the geographical area in which they live. The
people living in the areas with fertile soil would prefer grains, vegetables, dairy
products, etc. The people living in cold countries would be non-vegetarian and those
living in hot and humid areas would prefer lighter food. Geographical areas have
another sociological aspect, where the people of similar beliefs, language and
culture would live together, and the consumption would also be influenced
accordingly.
d) Economic development
There is an indirect association between the geographical area and its economic
development. But, the population leads to business, more investment, more
employment, and hence more economic development. World-over, the economic
development has happened in clusters, often in favourable physical conditions as
well. The fertile plains of Ganga, the coasts, the plains of Deccan have attracted
investment and have much better infrastructure as compared on far flung areas.
Peoples’ consumption changes significantly with the area’s economic development.
The requirements of cars, houses, material pleasures, etc. is highly influenced by the
economic development of that area.
The above discussion shows that the geographic features of an area have a lot of
influence on a firm and they must consider these aspects while deciding upon the
location of a firm, and then the strategies and plans to run the business operations.

B. Demographic environment
Demographic environment of a country refers to the pattern of population and the
changes in the societies, cities, regions and nations. It analyses the population
characteristics on the basis of age, gender, education, marital status, household
patterns, religion, nationality, ethnicity, etc. Demography provided an analysis of
qualitative as well as quantitative aspects of the population. Some of the issues
covered under demographic environment are:
a) Population size:
The very size of a population determines the size of the possible business. It
represents the potential to which the market can expand. By virtue of their
population, China and India are considered to be very powerful emerging
economies, overtaking even the developed nations. All the multinational companies
are making their way into these markets have tremendous potential for consumption.
b) Age distribution
In India, we are witnessing an increase in the population in the age group of 15-40
years, i.e., the productive people. This means that the economic prosperity of people
is likely to increase in the times to come. India is called Youngistan because the
young population represents hopes and aspirations and also the capacity and
energy to realize those dreams, and hence offers opportunities to the business firms.
On the other hand, we find an increasing population of old people in countries like
Japan. This is because of very low birth rates and high life expectancy. This can
influence the spending habits and business potential significantly.
c) Migration
The migration of people from villages to cities, and from the country to other
countries in search of job has a high influence on the business potential. People
increase their economic prosperity by movement and thus the business potential
grows. There is an increasing trend amongst the people to move towards
metropolitan cities, where there are more jobs, better living standards and a different
lifestyle.
d) Education and occupation
There is a trend towards higher education and preference for white collar jobs over
the blue collar jobs. This also has a tremendous impact on the spending habits of the
business.
e) Family size and structure
The size of family and its structure has a significant impact on the consumption
patterns. In the rural and semi-urban areas, still joint families exist. The members of
the family have an important say in the matters concerning other members. In the
cities, there is increasing trend towards nuclear families and their lifestyle and
consumption is undergoing a major change.
Demographic characteristics of population must be studied by the firms before they
decide to venture into any overseas market. In a fast changing society, the nature of
demographic indicators of the population is undergoing a change and each change
represents an opportunity to the business firms. The growth of several emerging
economies like China, India, Brazil, South Africa, etc. is largely due to the robust
demographic profile of these societies.

C. Economic environment
The economic environment is a major determinant of market potential and
opportunity. Since the single most important indicator of market potential is income,
the first step in determining the potential of a country or a region is to identify the
total, and even more significantly, the per capita income. In general, as peoples’
income rises, they spend less on the necessities and more on the discretionary
purchases. One of the ways of determining market potential for a product is to
evaluate product saturation levels. In general, it is appropriate to compare the
saturation levels of countries or of consumer segments with similar income levels.
Countries and markets go through typical stages of market development. Although,
development is on a continuum, it is possible to identify distinct stages and formulate
general estimates about the type of the market that will be found in a country or a
market at a particular stage of development. In advanced countries, for example,
more than half the GNP is accounted for by the services as opposed to goods. In
under-developed countries, the proportion of services is very low.

Changes in world economy

Over the years, several changes have taken place in the world economy, which have
changed the very manner of doing business. Keegan has identified the five most
significant changes in the world economy, which have occurred in the past decades,
and will influence the conduct of business. These changes are:
a) Increasing capital movement.
In the present time, capital movement rather than trade have become the driving
forces of world economy. The capital movement represents the attractiveness of a
country for investment. For example, by its favourable pro-business policies, China
has attracted the maximum investment. In no time, China is likely to emerge as the
manufacturing base for the whole world. Many countries were ahead of China in
terms of trade, but they feel the threat to their economy because of a sudden
increase in the economic potential of China, arising because of huge foreign
investment.
b) Jobless growth
Despite economic development, the production has become uncoupled from
employment and the Government of India claimed to have touched 8% growth in the
GDP, the growth is a jobless growth. The increase in productivity does not translate
into more jobs for the people. Such a situation is not good for the economies in the
long run because a large section of the society will be siphoned out of the economic
activities.
c) Value driven competition
The primary products have become uncoupled from the industrial economy and in
the industrial economy, focus is more on innovation and value addition and not mere
value addition. Michael Porter has stated in his book, “The Competitive Advantage of
Nations,” that as an economy progresses, it is driven by the factors of production,
namely land, labour, capital and management. However, after one stage, it stops
getting leverage out of mere factors of production. It becomes a wealth driven
economy. Here, wealth begets more wealth.
However, in long run, such a strategy is not going to deliver results. If an economy
aspires to grow further, it has to become an innovation driven economy. Thus,
primary products cease to the driving forces of the industry. Industry is going in for
rapid innovation and thus is aiming at delivering higher value to its customers.
d) Globalization
The global forces of the world economy are in control and the macro economics of
nation-states no longer control economic outcomes. Keegan observes a gradual
separation between economics and politics, although the shift is very subtle. The
economy is in the control of the market forces because more and more governments
are opening up and allowing business to work freely.
e) Free market economy
The free market economy, where market forces control the economy, the state
intervention has been reduced. The 75-year contest between capitalism and
socialism is over. The clear success of the capitalist system over the communist
centrally controlled model has led to the collapse of communism as a model of
organization of economic activity and as an ideology
By the above remarks, it is clear that the world economy is heading for a new world
economic order. The leftist forces are not as strong as they were on the yesteryears.
The world is no longer a bi-polar world, but is now a multi-polar world with many
regional economic groupings and powers. The democracy has shown a definite edge
over other systems and is likely to persuade more and more countries to allow free
play of the market forces.

Elements of Economic Environment

Economic environment is a multidimensional entity and it has dynamic interaction
with other environmental components as well. While there are many elements of the
economic environment, it comprises of five main components, as mentioned below:
a) Economic Conditions
b) Economic System
c) Economic Policies
 d) International Economic Environment
e) Economic Legislations
These components are explained in the following discussion.

a) Economic Conditions
In order to understand the economic condition, it is pertinent to have a look at the
state of economy of India since last decade. From the stage of ‘India Shining’ in
2004, when all the economic indicators showed a robust economic health of the
nation, today we are facing tough times. The inflation and interest rates are very
high, whereas the economic growth, budgetary deficit, value of rupee is touching the
lowest benchmarks. Deteriorating economic conditions have eroded the investment,
leading higher unemployment and the country is passing through a tough time.
Economic Policies of a business unit are largely affected by the economic conditions
of an economy. Any improvement in the economic conditions such as standard of
living, purchasing power of public, demand and supply, distribution of income etc.
largely affects the size of the market.
The economic condition passes through the business cycles, which has five stages -
Prosperity, Boom, Decline, Depression, and Recovery. The prudence of the
economists lies in how they are able to prolong the prosperity and boom, and reduce
the impact and duration of decline and depression. As explained earlier, Indian
economic is definitely passing through a phase of slowdown and the skill of the
economists managing the affairs lies in how they are able to get to the recovery
stage.
In order to assess the economic condition of a country, it is important to study the
following economic conditions:
(i) Stages of Business Cycle
(ii) National Income, Per Capita Income and Distribution of Income
(iii) Rate of Capital Formation
(iv) Demand and Supply Trends
(v) Inflation Rate in the Economy
(vi) Industrial Growth Rate, Exports Growth Rate
(vii) Interest Rate prevailing in the Economy
(viii) Trends in Industrial Sickness
(ix) Efficiency of Public and Private Sectors
 (x) Growth of Primary and Secondary Capital Markets
(xi) Size of Market

b) Economic Systems
An Economic System of a nation or a country may be defined as a framework of
rules, goals and incentives that controls economic relations among people in a
society. It also helps in providing framework for answering the basic
economic questions. Different countries of a world have different economic systems
and the prevailing economic system in a country affect the business units to a large
extent. Economic conditions of a nation can be of any one of the following type:-
(i) Capitalism
The economic system in which business units or factors of production are privately
owned and governed is called Capitalism. The profit earning is the sole aim of the
business units. Government of that country does not interfere in the economic
activities of the country. It is also known as free market economy. All the decisions
relating to the economic activities are privately taken. Examples of Capitalistic
Economy:- England, Japan, America etc.
(ii) Socialism
Under socialism economic system, all the economic activities of the country are
controlled and regulated by the Government in the interest of the public. The first
country to adopt this concept was Soviet Russia. The two main forms of Socialism
are: -
i. Democratic Socialism:- All the economic activities are controlled and
regulated by the government but the people have the freedom of choice of
occupation and consumption.
ii. Totalitarian Socialism:- This form is also known as Communism. Under this,
people are obliged to work under the directions of Government.
iii. Mixed Economy:- The economic system in which both public and private
sectors co-exist is known as Mixed Economy. Some factors of production are
privately owned and some are owned by Government. There exists freedom
of choice of occupation and consumption. Both private and public sectors play
key roles in the development of the country.
At the time of independence, India had opted for a socialist economy, which has
transformed into the market led economy. Although we have a free market economy,
the government and the government owned institutions play an important role in the
economy. Hence, we are a mixed economy even in the present times.
c) Economic Policies
Government frames economic policies. Economic Policies affects the different
business units in different ways. It may or may not have favorable effect on a
business unit. The Government may grant subsidies to one business or decrease the
rates of excise or custom duty or the government may increase the rates of custom
duty and excise duty, tax rates for another business. All the business enterprises
frame their policies keeping in view the prevailing economic policies. Important
economic policies of a country are as follows:-
(i) Monetary Policy
The policy formulated by the central bank of a country to control the supply and the
cost of money (rate of interest), in order to attain some specified objectives is known
as Monetary Policy.
(ii) Fiscal Policy
It may be termed as budgetary policy. It is related with the income and expenditure
of a country. Fiscal Policy works as an instrument in economic and social growth of a
country. It is framed by the government of a country and it deals with taxation,
government expenditure, borrowings, deficit financing and management of public
debts in an economy.
(iii) Foreign Trade Policy
It also affects the different business units differently. E.g. if restrictive import policy
has been adopted by the government then it will prevent the domestic business units
from foreign competition and if the liberal import policy has been adopted by the
government then it will affect the domestic products in other way.
(iv) Foreign Investment Policy
The policy related to the investment by the foreigners in a country is known as
Foreign Investment Policy. If the government has adopted liberal investment
policy then it will lead to more inflow of foreign capital in the country which ultimately
results in more industrialization and growth in the country.
(v) Industrial Policy
Industrial policy of a country promotes and regulates the industrialization in the
country. It is framed by government. The government from time to time issues
principals and guidelines under the industrial policy of the country.
d) Global/International Economic Environment

The role of international economic environment is increasing day by day. If any

business enterprise is involved in foreign trade, then it is influenced by not only its
own country economic environment but also the economic environment of the
country from/to which it is importing or exporting goods. There are various rules and
guidelines for these trades which are issued by many organizations like World Bank,
WTO, United Nations etc. Besides the above policies, Governments of different
countries frame various legislations which regulates and control the business.

Summary
The external environment is not a monolithic entity, but comprises of many
components. The physical features of an area have an important influence on the
settlement of populations and hence on the investment decisions of the firms.
Business prefers to grow around places with good accessibility, moderate climate
and sizable population. In addition to the numbers, the nature of human population
also has lot of influence on the businesses. The demographic characteristics, such
as the age profile of the population, the gender ratio, income, literacy, population
growth, health, etc. have a lot of influence on the consumption. The emerging
economies like India, China, Brazil, South Africa, etc. have a large proportion of
young population, triggering economic growth. The economic environment
comprises of several components, such as the economic conditions, economic
system, economic policies, international economic environment, and the economic
legislations. India has recently started experiencing the economic slowdown,
although it had remained aloof from the global economic slowdown for long. Various
economic policies - monetary, fiscal, foreign trade, foreign investment, and industrial
policies have a lot of influence on the economic environment of the countries. The
firms need to carefully monitor these components before taking the investment
decisions.