Business Environment

Meaning
Understanding the environment within which the business has to operate is very important for
running a business unit successfully at any place. Because, the environmental factors influence
almost every aspect of business, be it its nature, its location, the prices of products, the
distribution system, or the personnel policies. Hence it is important to learn about the various
components of the business environment, which consists of the economic aspect, the socio-
cultural aspects, the political framework, the legal aspects and the technological aspects etc.
In this chapter, we shall learn about the concept of business environment, its nature and
significance and the various components of the environment.
Organizations do not exist in a vacuum. Many factors enter into the forming of a company’s
strategy. The forces, conditions, situations, events etc. that impacts the organization are referred
to collectively as the organization’s environment. The environment of any organization
consists of aggregate of all conditions, events and influences that surround and affect it. It is
complex as well as dynamic in nature. Hence the factors of the environment influence various
business decisions. The ever changing environment poses numerous challenges to the business
firms to adjust and adapt itself to the realities of such environment. A firm’s environment
consists of internal environment (controllable) and external environment (uncontrollable).
Important decisions of the business such as:
• What business to do?
• Which customer segments to be targeted?
• Where and When to do the business?
• How to do the business?
• How to expand the business?
All these factors are influenced by the business environment.
Business Environment is the sum total of all external and internal factors that affect the
functioning of organization. It refers to the conditions, forces, events and situations within
which business enterprises have to operate.
Business environment refers to different forces or surroundings that affect business operations.
Such forces include customers, competitors, suppliers, distributors, industry trends, substitutes,
regulations, government activities, the economy, demographics, and social and cultural factors.
Others are innovations and technological developments.
The major features of business environment are as follows:
(1) Environment is inseparable part of business: Environment is an integral part of any
business. Business cannot work without environment. Business requires good framework of

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legal, political, social, cultural and economic factors. Both business and environment have
influence over each other.
They share a symbiotic relationship. Success of the business lies in understanding the
environmental changes and adapting the business policies accordingly. There is a mutual
interdependence between business and its environment. Business enterprises continuously
interacts with its environment for taking inputs like raw materials, capital, labour, energy etc.
and transform them into goods and services and then send them back to the environment.
(2) Environment is Dynamic: Business environment is dynamic in nature. No environment
remains constant or static for a longer period of time. The government may change certain
policies; there may be changes in consumer tastes, preferences etc. changes in technology also
affect the business. Environmental forces influence business decisions. The surrounding of
business enterprise that is constantly changing carries both opportunities and threats with them.
The success of business depends upon alertness and adaptability with the changing
environment.
(3) Business lacks control over environment: Business environment is a constantly
changing process. Business lacks control over external environment. It cannot directly
influence the changes in external environment. But it is possible to have influence over internal
environment. Internal environment is controllable whereas external environment is
uncontrollable.
(4) Internal and external factors: The environment of business comprises of internal and
external factors. Internal environment includes plans and policies, employees, business
objectives etc. The external environment is again subdivided into micro factor and macro
factor. Micro factor includes customers, suppliers, competitors, society etc. Macro factor
comprise of social, economic, legal, technological and other factors, which are unpredictable
and uncontrollable.
(5) Environment is complex: In the Business Environment, there are numerous complex
situations in which one must understand in order to maximize the benefits of success. Modern
business is more complex, flexible and highly un-predictable. The modern business has grown
in size and scope and so is the environment. Any change in the environment can adversely
affect the business organisation. Business environment is growing extremely complex due to
government interventions and social consciousness.
(6) Environment is multifaceted: Any change in the environment is followed by a chain of
positive and negative reactions. A change may be favourable to someone and unfavourable to
others. Changes in the environment can be perceived differently by different entrepreneurs.
Environmental changes may bring opportunities to some people and obstacles to others.
(7) Opportunities and obstacles: Business environment is flexible. It keeps on changing.
Sometimes it may provide opportunities to the business, whereas on the other hand may create
new challenges and obstacles in the working of the organisation. Opportunities may prove
favourable to the firm and obstacles may create threat and unfavourable to the firm affecting
its growth and profitability. Opportunities for growth and expansion is created when the

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environment is favourable, on the other hand it creates problems and obstacles when it is
unfavourable.
(8) Regulates the scope of business: Environment provides a framework within which
business organisation has to operate. All the business activities are expected to be conducted
within social, political, economic and legal structures. These changing structures should be
minutely monitored by the business firm for its survival and growth. The business must learn
to adjust itself with the ever-changing business environment.
(9) Long lasting impact: The environment can have both positive and negative impact on
the business. Changes in the environmental factors have long lasting effects on the functioning
of the business. These changes may create favourable and unfavourable impact on the firm. A
systematic analysis and diagnosis give strategies to anticipate opportunities and threats. This
helps to develop preventive measures to cope up with the threats effectively.
(10) Uncertainty: Business environment is largely uncertain, as it is very difficult to predict
future happenings, especially when environmental changes take place too frequently. The
enterprises must continuously monitor their environment and adopt suitable business practices
not only improve their present performance but also continue to succeed in the market for a
longer period.

Importance of Business Environment:

There is a close and continuous interaction between the business and its environment. This
interaction helps in strengthening the business firm and using its resources more effectively.
Thus business environment is multifaceted, complex, and dynamic in nature and has a far-
reaching impact on the survival and growth of the business. To be more specific, proper
understanding of the social, political, legal and economic environment helps the business in
the following ways:
(a) Determining Opportunities and Threats: The interaction between the business and its
environment would identify opportunities for and threats to the business. It helps the business
enterprises for meeting the challenges successfully.
(b) Giving Direction for Growth: The interaction with the environment leads to opening up
new frontiers of growth for the business firms. It enables the business to identify the areas for
growth and expansion of their activities.
(c) Continuous Learning: Environmental analysis makes the task of managers easier in
dealing with business challenges. The managers are motivated to continuously update their
knowledge, understanding and skills to meet the predicted changes in realm of business.
(d) Image Building: Environmental understanding helps the business organisations in
improving their image by showing their sensitivity to the environment within which they are
working. For example, in view of the shortage of power, many companies have set up Captive
Power Plants (CPP) in their factories to meet their own requirement of power.

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(e) Meeting Competition: It helps the firms to analyse the competitors’ strategies and
formulate their own strategies accordingly.
(f) Identifying Firm’s Strength and Weakness: Business environment helps to identify the
individual strengths and weaknesses in view of the technological and global developments.

Components of Business Environment

Business Environment can be broadly divided into two components:
(1) Internal Environment: It includes the factors that are controllable and hence can be
modified and altered by the organization. It comprises of value systems, mission, objectives,
plans and policies, management structure, human resources, financial resources, physical /
material resources, corporate image, labour-management relationships etc. Business can make
changes in these factors according to the change in the functioning of enterprise.
(2) External Environment: External environment is an attempt to understand the outside
forces of the organisational boundaries that are helping to shape the organisation. It includes
those factors which are beyond the control of business enterprise. It is of two types
(a) Micro/Operating Environment.
(b) Macro/General Environment.

Business Environment Components

Internal External
Environment Environment

Value Systems Micro Macro

Mission & Environment Environment
Objectives Customers Political
Corporate Image Suppliers Demographic
R&D Facilities Competitors Social
Human Resources Society Cultural
Financial/ Market Legal
Physical Intermediaries
Resources Technological
Internal Relations Natural
Plans and Policies Economic

(1) INTERNAL ENVIRONMENT:

(1) Value System: The value system has an important bearing on the choice of business,
mission and objectives of the organisations, business policies and practices. It is considered by
many firms in selecting suppliers, distributors, collaborators etc.

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Example:
(a) The value system of TISCO is fulfilling its social and moral responsibilities to
consumers, employees, shareholders, society and the people.
(b) Infosys views its employees as “key resource” It provides benefits to its employees in
way of training, loan housing, employee stock option plan and personal assistance services
which helps to attract top talent to contribute to its growth.
(2) Vision, Mission and Objectives: The vision, mission and objectives helps in guiding
the business philosophy, direction of development, business policy of the company. It helps to
answer the questions such as what, where, when and how the company needs to work in the
present and future.
(3) Management Structure: The important factors influencing the business decisions are
the organisation structure, board of directors and professionalization of the management. The
Board of Directors help in giving directions for the organisation development and to keep a
check on the performance of the organisation.
(4) Human Resources: Human resource helps in maintaining the quality of the employees.
Certain characteristics such as skills, quality, morale, commitment, attitude will contribute to
the strength and weakness of the organisation. Due to lack of involvement and initiative some
organisations find it difficult to adapt to modernisation.
(5) Corporate Image: Corporate image is the image of the firm in the minds of the
consumers which depends on the view of the society. The company’s image matters while
raising the finances, forming joint venture, entering purchase or sale contracts, launching new
products, etc. It is long term which is an important part of the environment which enhances
healthy relations with customers, employees, investors, suppliers, investors etc.
(6) Physical and Financial Resources: Physical resources include production capacity,
technology, distribution logistics, buildings, etc. It helps in creating a healthy working
atmosphere and retaining the employees in the organisations. Financial resources include
factors like financial policies, financial position and capital structure etc. which helps in smooth
conduct of the business and helps in fighting with the risks in the business.
(7) Internal Relations: It focusses on the relation between the employer, employee and the
management. Factors like the amount of support the top management receives from the
employees, shareholders and board of directors influences the decisions taken by the
management and its implementation in a peaceful manner.
(8) Plans and Policies: It helps as a guiding force in the working of the organisation.
Policies are made keeping in mind the objectives and goals of the firm.
(9) R&D facilities: Research and Development facilities help in adopting the latest
technology and standing in competitions with the rival companies.
(10) Marketing Resources: Marketing resources like quality of marketing men, organisation
for marketing, brand equity and distribution have a direct impact on efficiency of the market.

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(2) EXTERNAL ENVIRONMENT:
(A) Micro/Operating Environment:
The environment which is close to business and affects its capacity to work is known as Micro
or Operating Environment. It consists of Suppliers, Customers, Market Intermediaries,
Competitors and Public.
(i) Suppliers: They are the persons who supply raw materials and required components to
the company. They play a very important role in the smooth functioning of the business. They
must be reliable and business must have multiple suppliers i.e. they should not depend upon
only one supplier as it may adversely affect during conditions of strikes, lock outs or any other
production related issues.
(ii) Customers: Customers are regarded as the king of the market. Hence monitoring their
sensitivity is a top priority for any business organization. Success of every business depends
upon the level of their customer’s satisfaction. Organizations may have different categories of
customers like individuals, households, industries, other commercial establishments,
government and other Institutions etc.
(iii) Market Intermediaries: They work as a link between business and final consumers.
Types of market intermediaries are middlemen, marketing agencies, financial intermediaries,
physical intermediaries etc.
(iv) Competitors: Every move of the competitors affect the business. Organizations have to
constantly identify and monitor its competitors’ activities and adjust it according to their
strategies.
(v) Public: Any group who has actual interest in business enterprise is termed as public e.g.
media and local public. Local public may be established for mutual benefit of the company and
local community whereas, media public may be used to disseminate useful information.
Professional business firms maintain PR department to maintain relations, handle grievances,
welcome suggestions etc.
(B) Macro/General Environment:
It consists of all the factors that create opportunities and pose threats to business units.
Following are the elements of macro environment:
(i) Political and Government Environment
Business decisions are greatly influenced by the developments in the political environment.
The political environment including the characteristics and policies of the political parties, the
nature of constitution and government system and the government environment encompassing
the economic and business policies and regulations are among the factors of utmost importance
in the market selection and business strategy formulation.
A change in the government brings about a change in the attitude, preference, objectives etc.
Business firms need to keep a track of all political events, anticipate changes in government
policies and frame production and marketing strategies accordingly.
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The political environment is one of the less predictable elements in an organisation’s business
environment. It includes the effects of pressure groups who seek to change government
policies. It plays a very crucial role in strategic management of the business because:
• Political decisions inevitably affect the economic environment.
• Political decisions also influence the social and cultural environment of a country.
• Politicians can influence the pace at which new technologies appear and are adopted.

(ii) Economic Environment

Industry and business depend heavily on economic environment. The economic environment
has much to do with the scope of business, business prospects and the business strategy. The
survival of business and industry mainly depends on the purchasing power of the people and
purchasing power is largely a product of economic environment. The nature and level of
development of the economy, economic resources, size of the economy, economic policies,
economic conditions, supply and demand conditions etc. are all the factors relevant to the
business. Some of the factors of economic environment are:
• The economic structure adopted by the country (capitalist, socialist or mixed economy).
• The economic policies (Industrial Policy, Fiscal Policy, Monetary Policy).
• Economic planning (five year plans, annual budgets etc.)
• Infrastructural facilities like banks, insurance companies, transportation methods,
financial institutions etc.
• Economic indices like money supply, disposable personal income, savings rate,
exchange rate, income distribution etc.

(iii) Socio-Cultural Environment: The influence exercised by social and cultural factors that
are not within the control of business is known as socio-cultural environment. These factors
include: attitude of people to work, family system, caste system, religion, education, marriage
etc.
Examples:
(1) Nestle brews a very large variety of instant coffee to satisfy different national tastes.
(2) McDonalds does not serve beef and pork products in the Indian markets

(iv) Technological Environment

Technological environment includes the methods, techniques and approaches adopted for
production of goods and services and its distribution. The varying technological environments

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of different countries affect the designing of products. In the modern competitive age, the pace
of technological changes is very fast. Hence, in order to survive and grow in the market, a
business has to adopt the technological changes from time to time. It may be noted that
scientific research for improvement and innovation in products and services is a regular activity
in most of the big industrial organisations.

(v) Legal Environment

This refers to set of laws, regulations, which influence the business organisations and their
operations. Every business organisation has to obey, and work within the framework of the
law.

(vi) Demographic Environment

This refers to the size, density, distribution and growth rate of population. All these factors
have a direct bearing on the demand for various goods and services. For example a country
where population rate is high and children constitute a large section of population, then there
is more demand for baby products. Similarly the demand of the people of cities and towns are
different than the people of rural areas. The high rise of population indicates the easy
availability of labour. These encourage the business enterprises to use labour intensive
techniques of production. Moreover, availability of skill labour in certain areas motivates the
firms to set up their units in such area. For example, the business units from America, Canada,
Australia, Germany, UK, are coming to India due to easy availability of skilled manpower.
Thus, a firm that keeps a watch on the changes on the demographic front and reads them
accurately will find opportunities knocking at its doorsteps.

(vii) Ecological/ Natural Environment

The natural environment includes geographical and ecological factors that influence the
business operations. These factors include the availability of natural resources, weather and
climatic condition, location aspect, topographical factors, etc. Business is greatly influenced
by the nature of natural environment. For example, sugar factories are set up only at those
places where sugarcane can be grown. It is always considered better to establish manufacturing
unit near the sources of input. Further, government’s policies to maintain ecological balance,
conservation of natural resources etc. put additional responsibility on the business sector.

SWOT Analysis
For business it is important to know its surrounding environment from internal and external
point of view. Therefore it is important to evaluate environment opportunities in relation to the
strengths and weaknesses of the organization’s resources, and in relation to the organizational

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culture. SWOT analysis is one of the popular technique having applications in many areas. It
is the acronym for explaining strengths, weaknesses, opportunities and threats for any specific
organization.
SWOT analysis was evolved by Stanford Research Institute of USA in 1960s. It is a structured
planning method used to evaluate the strengths, weaknesses, opportunities, and threats
involved in a project or in a business venture. Some authors call SWOT as SCOT (Strength,
Contains, Opportunities, and Threats) or ETOP (Environment Threat and Opportunities
Profile).
SWOT analysis technique involves:
(1) Setting the objectives of the organization
(2) Identifying its strengths, weaknesses, opportunities and threats
(3) Asking the questions:
(a) How do we maximize our strengths?
(b) How do we minimize our weaknesses?
(c) How do we capitalize on the opportunities in our external environment?
(d) How do we protect ourselves from threats in our external environment?
(4) Recommending strategies that will optimize the answers from the above four questions.
A SWOT analysis can be carried out for a product, place, industry or person. It involves
specifying the objective of the business venture or project and identifying the internal and
external factors that are favourable and unfavourable to achieve that objective.

STRENGTHS:
Strength is an inherent capacity, which can be used for developing strategic advantage. It is the
positive competencies of a firm as compared to its competitors in the different functional areas
of production, marketing, personnel etc. Strengths can be tangible or intangible.
• Tangible Strengths – are visible like huge financial resources, favourable location, high
client retention, a user-friendly website, low staff turnover, maximum number of ATMs, low
overheads etc.
• Intangible Strengths – are not visible but have to be interpreted like organizational
learning capability, process capability, image etc.
Every firm should try and consolidate its strengths.
WEAKNESSES:
Weakness is an inherent constraints or limitations of the organization that prevent it in
achieving its objectives. It is the negative competencies of a firm as compared to its competitors

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in all functional areas of the organization. The weaknesses in an organizations. SWOT analysis
should list the areas where the organization is falling short of reaching its goals. Like strengths
weaknesses can be tangible or intangible.
• Tangible Weaknesses – depreciating machinery, insufficient funds, low customer
satisfaction, low staff morale etc.
• Intangible Weaknesses – lack of committed employees, poor top management practices
etc.
Every firm should make efforts to minimize its weakness.
OPPORTUNITIES:
Opportunities are favourable conditions, which enables an organization to strengthen its
present position. The opportunities section in an organizations. SWOT analysis should list the
areas where it has scope for growth or could take advantage of opportunities in the marketplace.
Since opportunities depend on the behaviour of various factors of environment, there may be
different types of opportunities like liberalization of economy provides opportunity to enter a
new business sector, lower interest rates provide opportunity for raising more funds through
borrowing to increase business volume etc.
Every firm should attempt to grab the right opportunity at the right time.
THREATS:
Threat is an unfavourable situation which results in risk and damage to an organization. Threats
emerge from various sources like economic slowdown, entry of a powerful competitor in the
market, emergence of a new substitute product making the existing product obsolete etc. For
example, a bank’s threats may include a declining economy, increased capital gains taxes, more
competitors in the marketplace, high unemployment or an increase in insurance rates.
Information about these aspects is collected, processed and analysed. Since this process
generates large volume of information, it becomes quite time consuming for higher
management to go through all the details of the analysis.
Benefits of Swot Analysis:
The main advantages of conducting a SWOT analysis is that it has little or no cost - anyone
who understands the business can perform a SWOT analysis. Using a SWOT one can:
• address weaknesses
• deter threats
• capitalize on opportunities
• take advantage of strengths
SWOT Analysis is:
• Simple to use

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• Involves low cost
• Flexible and can be adapting to varying situations
• develop business goals and strategies for achieving them
Limitations of Swot Analysis:
When an organization is conducting a SWOT analysis, it should keep in mind that it is only
one stage of the business planning process. For complex issues, it will usually need to conduct
more in-depth research and analysis to make decisions. A SWOT analysis only covers issues
that can definitely be considered a strength, weakness, opportunity or threat. Because of this,
it's difficult to address uncertain or two-sided factors, such as factors that could either be a
strength or a weakness or both, with a SWOT analysis (e.g. organization might have a
prominent location, but the lease may be expensive).
A SWOT analysis may be limited because it:
• does not prioritize issues
• does not provide solutions or offer alternative decisions
• can generate too many ideas but may not actually help choose which one is best
• can produce a lot of information, but not all of it may be useful.
SWOT analysis is still being used as an important tool in organizations. Strategy formulation
starts with SWOT analysis, which involves assessing the strategic fit between external
opportunities and internal strengths and external threats and internal weakness. SWOT analysis
can help to gain insights into the past and think of possible solutions to existing or potential
problems — either for an existing business or new venture.

Need for Analysis of Business Environment

An organization performs an environmental analysis to gain an understanding of its strengths,
weaknesses, opportunities and threats. The environmental analysis then influences corporate
planning and policy decisions. Analysis of environment is essential because of following
reasons:
(1) A tool to anticipate changes: Environmental analysis is a very useful tool not only to
understand business surroundings, but also as a good instrument to anticipate the changes and
be prepared to face the challenges of such changes.
(2) Identification of strength: Strength of the business firm means capacity of the firm to
gain advantage over its competitors. Analysis of internal business environment helps to identify
strength of the firm. After identifying the strength, the firm must try to consolidate or maximise
its strength by further improvement in its existing plans, policies and resources.
(3) Identification of weakness: Weakness of the firm means limitations of the firm.
Monitoring internal environment helps to identify not only the strength but also the weakness
of the firm. A firm may be strong in certain areas but may be weak in some other areas. For

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further growth and expansion, the weakness should be identified so as to correct them as soon
as possible.
(4) Identification of opportunities: Environmental analyses helps to identify the
opportunities in the market. The firm should make every possible effort to grab the
opportunities as and when they come.
(5) Identification of threat: Business is subject to threat from competitors and various
factors. Environmental analysis help them to identify threat from the external environment.
Early identification of threat is always beneficial as it helps to diffuse off some threat.
(6) Optimum use of resources: Proper environmental assessment helps to make optimum
utilisation of scare human, natural and capital resources. Systematic analyses of business
environment helps the firm to reduce wastage and make optimum use of available resources,
without understanding the internal and external environment resources cannot be used in an
effective manner.
(7) Survival and growth: Systematic analyses of business environment help the firm to
maximise their strength, minimise the weakness, grab the opportunities and diffuse threats.
This enables the firm to survive and grow in the competitive business world.
(8) To plan long-term business strategy: A business organisation has short term and long-
term objectives. Proper analysis of environmental factors help the business firm to frame plans
and policies that could help in easy accomplishment of those organisational objectives. Without
undertaking environmental scanning, the firm cannot develop a strategy for business success.
(9) Environmental scanning aids decision-making: Decision-making is a process of
selecting the best alternative from among various available alternatives. An environmental
analysis is an extremely important tool in understanding and decision making in all situation
of the business. Success of the firm depends upon the precise decision making ability. Study
of environmental analysis enables the firm to select the best option for the success and growth
of the firm.
(10) Enhances Corporate Image: Environmental analysis helps to improve the overall
performance of the organization. Thus the image of the organization improves in the minds of
all the stakeholders.
(11) Employee Motivation: Environmental analysis makes business proactive, firms take
quick and quality decisions. This improves the performance of employees. They are motivated
as they get higher incentives.

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