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L-1: Environment of Business

This lesson deals with:-
1. Introduction to Business Environment
2. Internal Environment
3. External Environment
4. Issues in Management of Public Limited Company

1. Introduction to Business Environment:

The Business Environment (BE) is the environment of a
business organization, which is the aggregate of all
conditions, events and influences that surround and
affect it. Due to its complex, dynamic and multifaceted
nature, as well as its far-reaching impact, the BE
exhibits many characteristics. Consequently, dividing
the environment into (i) Internal and (ii) External
components enables its better understanding. Every
business enterprise has to cope with Internal Factors
(Controllable) as well External Factors (Uncontrollable).

Corporate Environment (CE) comprises of (i) Players,
(ii) Issues, (iii) Responses, and (iv) Challenges. CE in
turn depends on Business Environment. All the relevant
environmental factors influence the CE.

There is a wide variation in environmental factors from
country to country and even region to region. The BE is
an extremely complex and dynamic phenomenon.


The two (2) major categories of BE:

(i) Economic Environment:
Fiscal Policy
Monetary Policy
Industrial Policy
The physical limits on Output, Price, Income.
Nature of Economic System
Pace of Economic Development

(ii) Non-Economic Environment:
Social Factor
Cultural Factor
Political Factor
Legal factor
Technological Factor

While the economic environment has non-economic
implications, the non-economic environment has
economic implications too. Considerable skill and
dexterity is required in adjusting, coping with and
managing the BE.

A study of the critical elements of the BE is essential to
facilitate the development of these skills. An
understanding of this turbulent and dynamic
environment also helps in effective decision making by
business managers.

Importance of BE:

Since the world of business today is ever changing
and dynamic, understanding of BE helps the
managers in right decision making.
BE helps the managers to understand the risk
associated with the business as well as corporates.
If the managers stay abreast of external
developments and react accordingly, it will help
them in solving their problems effectively and
running the firms efficiently.
2. Internal Environment:

The environment and its different sectors have to be
constantly monitored by business managers for
opportunities and threats that have or likely to have an
impact on their organization. Such monitoring is done
by means of environmental scanning.

The Internal Environment (IE) comprises of the
resources, synergy and distinctive competencies of a
firm. These together determine its organizational
capabilities in terms of its strengths and weaknesses
existing in the different functional areas marketing,
operations, personnel, financial, technical, etc.

Thus the firms capabilities in the above mentioned
functional areas in addition to the firms strategy and
structure make up the dynamics of its IE. However, IE
gets constantly influenced by the external environment

Following are the Internal factors since the business
enterprise generally has control over these factors:-
(i) Strategy
(ii) Structure
(iii) Personnel Capability
(iv) Marketing Capability
(v) Operations capability
(vi) Financial capability
(vii) Technical capability

The above Internal factors can be altered or modified
by the organization with greater ease to suit the
environment. They are described below:-

(i) Strategy:

Strategy is a unified, comprehensive and integrated
plan relating to the strategic advantages of the firm to
the challenges of the environment. It is designed to
ensure that the basic objectives of the enterprise are

Strategy involves establishing the proper organization-
environment matching the organizational factors with
the environmental factors. It involves an analysis of the
organizational factors (strengths and weaknesses) and
the environmental factors (opportunities and threats) in
the BE.

Strategy serves as a blue print indicating the courses of
action to achieve the desired objectives. The influence of
strategy on IE of an enterprise can be understood from
the following points: -
Strategy determines organizational tasks
Strategy influences the choice of technology
Strategy defines a BE and gets defined by the latter

(ii) Structure:

Some of the important factors influencing the
business decisions are the organization structure, the
composition of the Board, the extent of
professionalization of management, etc. The
organization structure is affected by the size, nature
and diversity of the business; the characteristics of
the market; the future business plans; etc. Changes in
the strategy of a business may necessitate changes in
the structure. Organization structure needs to be
flexible to respond to changes in the market.
Similarly, decision-making is delayed if there is a long
hierarchy or more layers in the administrative

(iii) Personnel Capability (PC):

PC factors are those that are related to existence and
use of human resources and skills related aspects that
have a bearing on the ability of an organization to
implement strategies to attract and retain human
resources. Some of the important PC factors are: -
Personnel System (manpower planning,
selection, development, compensation,
communication, appraisal, etc)
Employees Characteristics (corporate image,
quality of managers, staff and workers,
employee promotion opportunities, working
conditions, etc.)
Industrial Relations (relationship between
union and employees, collective bargaining,
safety, welfare and security, employee
satisfaction, employee morale, etc.)


(iv) Marketing Capability (MC):

MC factors are those related to pricing, promotion and
distribution of products or services and all aspects
relating to the ability of the firm to market its products
and services. The factors which influence the MC are: -
Product related factors (variety, differentiation,
positioning, packaging, etc.)
Price-related factors (pricing objective, policies,
changes, protection, advantages etc.)
Promotion related factors (promotional tools, sales
promotion, advertising, public relations, etc.)
Integrative and systematic factors (marketing mix,
distribution system, company image, marketing
organization, system and management, information
system, etc.)

(v) Operaions Capability (OC):

OC factors are those related to production of products
or services, use of material resources, all related aspects
that have a bearing on the capacity and ability of the
organization to implement its strategies to produce
products and services. Some of the OC factors are:-
Factors related to production system (capacity,
location, layout, product/service design,
automation, vertical integration, etc.)
Factors related to operation and control system
(aggregate production, planning, material supply,
inventory, cost and quality control, maintenance
system and procedure, etc.)
Factors related to R&D (product development,
patent right, level of technology, technical
collaboration and support, etc.)

(vi) Financial Capability (FC):

FC factors include those related to the availability,
usage and management of funds and all related aspects
having bearing on the capacity and ability of the
organization to implement its strategies to procure and
disburse funds. Such FC factors are:-
Those related to the sources of funds (capital
structure, procurement of capital, financing
pattern, availability of working capital,
borrowings, capital and credit availability, reserves
and surpluses, relationship with banks, lenders and
FIs, etc.)
Those related to the use of funds (capital
investment, fixed assets acquisition, current assets,
loans and advances, dividend distribution, and
relationship with shareholders).
Factors related to management of funds (financial
accounting, budgeting, management control
system, state of financial health, cash, inflation,
credit, return and risk management, cost reduction
& control, and tax planning and control).

(vii) Technical Capability (TC):

TC implies strategy for organizational fitness. Most
product development organizations recognize that the
capability of their technical staff is critical to improving
their productivity and quality in achieving their
business goals. (Example: BMW for elegance and
design which speaks for its technical capability; BHEL
for its designing of steel turbines).

3. External Environment:

All the factors that provide opportunities or pose
threats to an organization make up the external
environment of the organization. The external
environment, in a broader sense encompasses a variety
of factors like international, national and local
economy. The environment is made up of social
changes, demographic variables, political system,
technology, government or public attitude towards
business, energy sources, availability of raw materials
and other resources, and several other macro level
factors. The immediate concern of an organization
would be to concentrate on those external factors that
are intimately related to its very existence and
profitable performance.

Following are the individual factors of the external
environment: -

(i) Demographic Environment:

Demand for goods and services is affected by
demographic factors such as population size,
growth rate, gender composition, life expectancy,
family size, spatial dispersal, occupational status,
employment pattern, etc. which have implications
for business. Heterogeneity of labor in terms of
language, caste, religion and ethnicity, etc. is likely
to make personal management a more complex

(ii) Social Environment:

Buying and consuming pattern of people, their
beliefs and values, languages, customs and
traditions, tastes and preferences, education etc.
are some important factors and influences
operating the firm in the social environment.

(iii) Cultural Environment:

Cultural forces play a major role in shaping a
companys marketing mix program. The cultural
elements are: language; aesthetics like art, drama,
music, folklore and architecture present in a
society; education; and religion.

(iv) Political Environment (PE):

PE refers to management of public affairs and
their impact on business. PE is closely related to
the economic system and economic policy. Some
governments specify certain standards for the
products, including packaging, while others
prohibit marketing of certain products.
Promotional activities are subject to various types
of controls in most nations. Indian government
plays an active role as a planner, promoter and
regulator of economic activity and India has a
stable political system.

(v) Economic Environment (EE):

EE is made up of macro level factors relating to
production and distribution of wealth that affects
an organization. Some of the factors influencing EE
are: (i) Economic Structure e.g. capitalistic,
socialistic or mixed economy; (ii) Economic
Planning such as 5-year plans, budgets, etc;
Economic Policies like monetary, industrial and
fiscal policies; (iii) Economic Indices like national
income, per capita income, disposable personal
income, GNP growth rate, distribution of income,
saving rate, imports and exports, balance of
payments, etc.; and (iv) Infrastructural Factors
such as Financial Institutions (FIs), banks,
communication facilities, modes of transport,
energy source, etc.
(vi) Financial Environment (FE):

The financial system constitutes an integral part of
the economic system covering (i) flow of savings to
provide funds for investments in industry, trade
and service organizations; (ii) financial
intermediaries like banks, NBFCs and FIs to
service them; and (iii) financial instruments and
securities that facilitate transfer of funds. Money
and capital markets contribute greatly to the
development of business and industry and are
integral part of business environment.

(vii) Trade Environment (TE):

Economic reforms worldwide have led to global
trade which is the universal rule of business to-day.
Globalization refers to the integration of the world
into one huge market. There were many efforts to
reduce the trade barriers like import-export duties
and non-trade barriers like import quotas, export
subsidies, countervailing duties, dumping, etc. and
also reduce the gap between the domestic prices
and world prices, thus liberalizing the trade gap.
WTO has been established and General Agreement
on Trade and Services (GATS), Trade-Related
Intellectual Property Rights (TRIPs), Trade-
Related Investment Measures (TRIMs) have been
brought under its purview for establishing a better
trade environment.


(viii) Technological Environment (TE):

TE comprises of the factors which are related to the
applied knowledge and the materials and machines
used in the production of goods and services. The
main factors and influences operating in the
technological environment are:
Sources of Technology (Company sources,
external sources and foreign sources; cost of
acquisition of technology; and collaboration in
and transfer of technology)
Technological development, stages of
development change, rate of change of
technology, and research and development.
Impact of technology on human beings, the
man-machine system, and the effects of
technology on environment.
Communication and infrastructural
technology and technology in management.

In Indian context, there is variation in the state of
technological development among different sectors of
the industry.

(ix) Legal Environment:

A unique system of law prevails in every country to
regulate their corporate entities. This makes a
multinational corporation to cope up with widely
different legal systems of varied complexity and
dimensions. In some countries, the laws do not specify
every detail and their interpretations are left to the
courts. Hence a foreign enterprise has to be
scrupulously careful to abide by the local laws and
regulations. Since there is no international body to
make rules and oversee the fulfillment of rules by
different parties, the jurisdiction of laws gains
importance when disputes arise. To control foreign
businesses in their economies, host countries enact
laws, which take several forms such as tariffs,
antidumping laws, export/import licensing investment
regulations, legal incentives, and restrictive trading

(x) Regulatory Environment:

Regulatory environment comprises factors related to
the planning, promotion, and regulation, by the
government, of those economic activities that affect the
business of the organization. Such factors are:-
The constitutional framework, directive principles
of state policy, fundamental rights, and division of
legislative power between central and state
Policies relating to licensing monopolies, foreign
investment and financing of industries.
Policies related to distribution and pricing and
their control.
Policies related to imports and exports.
Other policies related to the public sector, small-
scale industries, sick industries, development of
backward areas, control of environment pollution
and customer protection.

Since the Indian economy is by and large centrally
planned and controlled, the economic activities are
regulated by public authorities in the larger interest.
Business and industry operate within a regulatory
environment. A two-way relationship exists between
the industry and the regulatory environment. The
policies, procedures and rules according to which
industry functions are laid down by the government.

(xi) Tax Environment:

Governments design tax systems to raise revenues
and promote economic and social goals. While at
times government attempts to stimulate overall
national economic activity through tax reduction, at
other times, they attempt to retard excessive growth
through tax hikes. To stimulate productive activity,
the government may extend tax concessions to certain
industries. The Indian government has been
promoting infrastructure and IT sectors through
attractive tax incentives.

Similarly tariffs may be imposed by government on
imported manufactured goods to discourage the
outflow of FE reserves or to shelter a domestic
industry from the onslaught of foreign competition
(Example: Automobile Industry).

(xii) Ethical Environment (ETE):

In every society, there will be some dos and donts.
The principle of morality or rules of conduct are
referred to ethics. Ethics deals with identification of
rules that should govern the behavior of people. A
situation, problem or opportunity in which an
individual must choose among several actions that
must be evaluated as right or wrong is what
comprises an ethical issue. Likewise the moral
principles and the standards that guide behavior in
the world of business comprise business ethics and
corporate governance.

Due to the highly publicized unethical activities by
businesses, the demand for ethical behavior has
increased. Decision made on the basis of what is
right and what is wrong constitutes the ethical
environment of an organization. Increasingly,
managers are realizing the importance of
separation of management from ownership of a
company to ensure the observance of a code of

4. Issues in Management of Public Limited Company:

This chapter is covered in a separate lesson (L_I A)