Business and Regulatory Environment

Section 1 Introduction to business

Chapter 1 Business environment

1.1

Organisation in its environment

A business is influenced by the environment in which it operates and the success of any business is
dependent on its ability to adapt to its environment. It is a combination of internal and external factors that
influence a company's operating situation.
There are many different environments within which each business operates. There is the macro
environment, which in todays global economy refers to the whole world, where events often indirectly
impact on businesses and there is the microenvironment, local events and circumstances which directly
affect and interact with a business.

1.1.1

Macro environment

Macro environment covers all those factors influencing all organisations indirectly, such as government
policies (fiscal, monetary, foreign, infrastructure and industry policies), general economic trends,
unemployment and population growth, and the effect of new technologies. One method of analyzing
these factors are by grouping them into four categories, abbreviated as PEST (political and legal,
economic, social and cultural, technological). This method is known as PEST analysis.

1.1.1.1 Political and legal factors

Changes in politics and law can affect just about any aspect of a businesss operations and decision
making. As multinational companies operate in more than one country, they are affected by legal and
political changes in each of those countries. Some examples are given below:

Nationalisation or privatisation of industries whole or part transfer of ownership from private

owners to the state (nationalisation) or transfer of ownership from the state to the public or
commercial companies (privatisation or de-nationalisation);
General legal framework (contract and agency law) These define the general way of doing
things;
Criminal law Issues like theft, bribery, insider trading;
Company law Formation of companies, running of companies by management and roles and
responsibilities of directors, internal and external reporting requirements, rights of shareholders,
liquidation / take overs;
Competition law avoidance of anti-competitive practices, prevention of formation of monopolies,
anti-collusion regulations, price controls;
Employment law Minimum wages, working conditions, dismissals, redundancy, leaves,
discrimination, equal opportunities, trade unions;
Consumer protection laws Rights of consumers relating to refunds, replacements, warranties,
protection of specific consumer groups against sale of harmful products such as cigarettes and
alcohol etc.
Health and safety law Precautions against fires, injuries, minimum health and safety standards
specially for high risk work places (such as construction, food processing, chemical processing);
Data protection law Ownership, use and distribution of information on employees, customers;
Environmental laws Controls and limits on pollution, disposal of waste materials, clean-up costs
Tax laws Corporate tax, income tax, social insurance contributions, indirect taxes. Governments
can reduce tax rates or give tax subsidies to encourage a particular business segment, or raise
tax rates to increase income from a business segment or to encourage the reduction in
consumption. An example is taxation of fuel, which may be increased to influence and reduce the
amount of fuel used in the country.

Laws applicable to a business may imposed by international bodies (such as the European Union, World
Bank or the International Accounting Standards Board), national bodies empowered by the national
governments, local bodies on which some decision making powers have been delegated by national or
regional governments.
1.1.1.2 Economic factors
Governments are in a unique position to influence the economic environment of a country. They might do
this to improve the overall performance of the economy and achieve certain policy objectives. A few of
them might be:

Sustained economic growth - Economic growth occurs when real output (the gross domestic
product adjusted for changing prices) of an economy increases over time. Sustainable economic
growth means a rate of growth which can be maintained without creating other significant
economic problems for future generations. There is a trade-off between rapid economic growth
today, and growth in the future. Rapid growth today may exhaust resources and create
environmental problems for future generations, including the depletion of natural resources;
Stable prices When the prices of goods and services do not rise rapidly, inflation is said to be
low. For most economies, it is an achievement if inflation rate is maintained at an acceptable low

level, as a low inflation encourages consumers to buy goods and services. Low inflation also
makes it more appealing to borrow money as interest rates are usually low during periods of low
inflation. However, if inflation turns negative (deflation), it is considered as a shrinking economy
and is usually followed by governments and central banks taking measures to stimulate the
economy.
High level of employment Unemployment occurs when a person who is actively searching for
employment is unable to find work. Unemployment is often used as a measure of the health of
the economy.
Sustainable position in the countrys balance of payments This summarises an economys
transactions with the rest of the world for a specified time period. In the long term, a country with
a trade deficit has to rely on foreign direct investment or borrow money to make up the
difference.

Governments can manage the countrys economy using either one or both of the following policies:

Fiscal policy - Fiscal policy involves the use of government spending, taxation and borrowing to
influence both the pattern of economic activity and also the level and growth of demand, output
and employment. Higher government spending and lower taxation drive economic activity and
inflation higher.
Monetary policy - Monetary policy involves the use of interest rates to control the level and rate
of growth of aggregate demand in the economy. The higher the interest rates, greater is the
incentive for people to save money, while lower interest rates motivate higher spending and
economic activity.

1.1.1.3 Technological factors

Businesses are constantly developing new technologies to provide the best solutions for the market
place. Companies try to find out the most appropriate technologies are for their customers and adopt
them. Advances in technology can play a major role in faster economic growth. On one hand, they can
provide new products that create new demand for goods and services in the economy, while on the other,
they can reduce the time and cost required to produce or provide goods and services, so that the same
level of resources can give a higher output.
Technological progress is the key to a countrys long-term increase in its material well-being, as a country
that is able to increase the output of goods and services faster than its population growth can improve its
citizens standard of living.
However, a contrasting effect of rapid technological advances may cause higher unemployment, if new
technology decreases the requirement of labour for the same output of goods and services.
1.1.1.4 Social and demographic factors
Social factors in an environment include changes in habits, tastes, values, preferences and fashion.
Demographic changes refer to the size, quality, and distribution of the population.
These changes may have a major impact on business. The output of an economy can be drastically
changed by changing the availability or quality of the workforce available, the behaviour of people and the
culture in the economy. Population growth, increased urbanization, a widening divide between countries
with youthful and quickly aging populations and a rapidly growing middle class are reshaping not only the
business world, but also society as a whole. Some examples are given below:

Population growth This has both positive and negative effects on an economy.
Rapid population growth rates can make it difficult for countries to raise standards of living and
protect the environment because the more people there are, the greater the need for food, health
care, education, houses, land, jobs, and energy. Adding more people to a countrys population
means that the countrys wealth must be distributed among more people, at least in the short
term.
On the positive side, however, higher population denotes a higher level of consumption of goods
and services. There is a greater supply of labour, so employers have the opportunity to engage a
better quality of workforce, driving productivity. In the long run, if a government can manage
unemployment and its resources, higher population goes hand in hand with a growing economy.

Average age Countries like China and Japan have a decreasing ratio of young people to the
total population. This means that the people entering the work force will be more expensive, due
to competition between employers trying to hire the best talents. On the other side, a rising ratio
of older people means that there are more and more people retiring and exiting the job market,
who have to be supported by the shrinking young and middle-aged working population.
Trends Going green used to be a signal of a businesss intent to care more about its
immedisate environment. However, in todays world, cleaner technology has become a
competitive advantage. With rising fuel and energy costs all around the world, governments and
organizations are announcing plans to shrink their carbon footprints to a low-carbon, resourceefficient business model. As this transformation accelerates, global corporations are increasingly
realizing that they must understand the impact of clean-tech on their industries and develop
strategic plans to adapt to this change. Governments also view clean-tech as a national strategic
platform for creating jobs, fostering innovation and establishing local industries. This inevitable
move to a low-carbon, resource-efficient economy presents an opportunity to stake out and
capture a strategic competitive position for governments, innovators, investors and corporations.
Migration This includes both short and long term movement of people. Popular tourist
destinations usually have a low population, but their economy depends on people from other
countries travelling at least once a year during holidays. Also, countries like the United States,
Canada, Spain and Australia have a large number of immigrants entering their countries and the
job market.

Government policies can impact the social and demographic changes in the environment using a number
of measures, such as:

1.1.2

Changing the immigration policy to allow or restrict the inflow of people directly entering the
working population;
Increasing the retirement age at which individuals may retire;
Subsidies or taxes to couples to have more / less children. China, for example, has a one-child
policy since 1979, enforced through fines on the family income and other measures.
Micro environment

The micro environment refers to the forces and immediate challenges that are close to the business itself
and have a direct impact on the businesss operations and success. Businesses can directly address how
they take control over all the challenges and influences in the micro environment. It includes the company
itself, its owners, employees, suppliers, customers, competitors and regulators.

1.1.2.1 Owners
As organisations require investment to grow, they may decide to raise money by floating on the stock
market i.e. move from private to public ownership. The introduction of public shareholders brings new
pressures as public shareholders want a return from the money they have invested in the company.
Shareholder pressure to increase profits will affect organisational strategy. Relationships with
shareholders need to be managed carefully as rapid short term increases in profit could detrimentally
affect the long term success of the business.
1.1.2.2 Employees
Employing staff with relevant skills and experience is essential to any business. This process begins at
recruitment stage and continues throughout an employee's employment via ongoing training and
promotion opportunities. Training and development play a critical role in the business achieving a
competitive edge over its competitors. If a business employs staff without motivation, skills or experience
it will affect customer service and ultimately sales.
1.1.2.3 Suppliers
Suppliers provide businesses with the materials they need to carry out their business activities. A
supplier's behaviour will directly impact the business it supplies. For example if a supplier provides a poor
service this could increase timescales, product quality or costs. An increase in raw material prices will
affect an organisation's marketing strategy and may even force price increases. Close supplier
relationships are an effective way to remain competitive and secure quality products. Apple Inc. for
example, is famous for investing substantially in the production processes in partnership with its
suppliers, and for providing training and development. Rather than moving into areas of manufacturing
that they dont understand, they provide the cash to invest and guaranteed initial sales to their suppliers,
in return for high quality and low cost parts for their devices that are exclusive to Apple for the first couple
of years production.
1.1.2.4 Customers
As all businesses need customers, they are focussed around the needs of their customers. The firm's
marketing plan should aim to attract and retain customers through products that meets their "wants and
needs" and excellent customer service. There are different types of customer markets including consumer
markets (individuals who purchase goods and services for their personal use), business markets (that buy
goods and services for use in their own products), government markets (that buy goods to produce public
services or transfer goods to others who need them), reseller markets (purchase goods to resell as is for
a profit), and international markets (all of the above but in other countries.
1.1.2.5 Competitors
To remain competitive a company must consider who their biggest competitors are while considering its
own size and position in the industry. The company should develop a strategic advantage over their
competitors.
The intensity of competitive rivalry within an industry will affect the profitability of the industry as a whole.
Competitive actions might take the form of price competition, advertising battles, sales promotion
campaigns, introducing new products for the market, improving after sales service or providing
guarantees or warranties. Competition can stimulate demand, expanding the market, or it can leave

demand unchanged, in which case individual competitors will make less money, unless they are able to
cut costs.
Three levels of economic competition have been classified:

The most narrow form is direct competition, where products which perform the same function
compete against each other. Sometimes, two companies are rivals and one adds new products to
their line, which leads to the other company distributing the same new things, and in this manner
they compete.
The next form is substitute or indirect competition, where products which are close substitutes for
one another compete.
The broadest form of competition is typically called budget competition. Included in this category
is anything on which the consumer might want to spend their available money. For example, a
family which has $20,000 available may choose to spend it on many different items, which can all
be seen as competing with each other for the family's expenditure. This form of competition is
also sometimes described as a competition of "share of wallet".

QUESTIONS
1) What are the key differences between the macro and micro environments?
Microeconomics and macroeconomics both focus on the distribution of scarce resources. Both study
how the demand for certain resources interacts with the ability to supply that good to determine how
to best distribute and allocate that resource among many consumers.
Microeconomics studies the behavior of individual households and firms in making decisions on the
allocation of limited resources. It has a much narrower focus as it deals with particular markets, and
segments of the economy.
Macroeconomics is focused on global economics or nation specific economics. Its studies involves
the total sum of economic activity, dealing with the issues such as growth, inflation,
and unemployment.
2) What are some of the effects of macro and microeconomics on decision making?
When macroeconomic trends are analyzed, one can have a better understanding of the stableness of
the overall business environment. When microeconomic indicators are identified as being positive,
the company can look to grow. It will however be beneficial to further examine the macroeconomic
environment to identify if companies overall are expanding. It is therefore vital to balance business
decisions based on the understanding of local as well as economic trends.

1.1.2.6 Regulators
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1.1.3

Porters five forces

Porter five forces analysis is a framework for industry analysis and business strategy development formed
by Michael E. Porter of Harvard Business School in 1979. It draws upon industrial organization (IO)
economics to derive five forces that determine the competitive intensity and therefore attractiveness of a
market.

Threat of new entrants

Profitable markets that yield high returns will attract new firms. This results in many new entrants, which
eventually will decrease profitability for all firms in the industry. Unless the entry of new firms can be
blocked by factors, the abnormal profit rate will tend to decrease.
The following factors can have an effect on how much of a threat new entrants may pose:

The existence of barriers to entry (patents, rights, etc.). The most attractive segment is one in
which entry barriers are high and exit barriers are low. Few new firms can enter and nonperforming firms can exit easily.
Government policy
Capital requirements
Cost disadvantages independent of size
Economies of scale
Product differentiation
Brand equity
Switching costs
Customer loyalty to established brands
Industry profitability (the more profitable the industry the more attractive it will be to new
competitors)

Threat of substitute products or services

The existence of products outside of the realm of the common product boundaries increases the
propensity of customers to switch to alternatives. For example, drinking water might be considered a
substitute for Coke, whereas Pepsi is a competitor's similar product. Increased marketing for drinking
water might "shrink the pie" for both Coke and Pepsi, whereas increased Pepsi advertising would likely
"grow the pie" (increase consumption of all soft drinks), albeit while giving Pepsi a larger slice at Coke's
expense. Another example is the substitute of traditional phone with VoIP phone.

Potential factors:

Buyer propensity to substitute

Relative price performance of substitute
Buyer switching costs
Perceived level of product differentiation
Number of substitute products available in the market
Ease of substitution. Information-based products are more prone to substitution, as online product
can easily replace material product.

Bargaining power of customers (buyers)

The bargaining power of customers is also described as the market of outputs: the ability of customers to
put the firm under pressure, which also affects the customer's sensitivity to price changes. Firms can take
measures to reduce buyer power, such as implementing a loyalty program. The buyer power is high if the
buyer has many alternatives.
Potential factors:

Buyer concentration to firm concentration ratio

Degree of dependency upon existing channels of distribution
Bargaining leverage, particularly in industries with high fixed costs
Buyer switching costs relative to firm switching costs
Buyer information availability
Force down prices
Availability of existing substitute products
Buyer price sensitivity
Differential advantage (uniqueness) of industry products
The total amount of trading

Bargaining power of suppliers

The bargaining power of suppliers is also described as the market of inputs. Suppliers of raw materials,
components, labor, and services (such as expertise) to the firm can be a source of power over the firm
when there are few substitutes. If you are making biscuits and there is only one person who sells flour,
you have no alternative but to buy it from them. Suppliers may refuse to work with the firm or charge
excessively high prices for unique resources.
Potential factors:

Supplier switching costs relative to firm switching costs

Degree of differentiation of inputs
Impact of inputs on cost or differentiation
Presence of substitute inputs
Strength of distribution channel
Supplier concentration to firm concentration ratio
Employee solidarity (e.g. labor unions)
Supplier competition: the ability to forward vertically integrate and cut out the buyer.

Intensity of competitive rivalry

For most industries the intensity of competitive rivalry is the major determinant of the competitiveness of
the industry.
Potential factors:

Sustainable competitive advantage through innovation

Competition between online and offline companies
Level of advertising expense
Powerful competitive strategy
Firm concentration ratio
Degree of transparency

QUESTIONS
1) What is the importance of Porters Five Forces in business?
The five forces model relates to the bargaining power of buyers and suppliers, threat of new
competition, threat of substitute products and industry competition. It determines a companys
competitive environment that affects profitability. The bargaining power of customers and suppliers
will affect a companys ability to increase prices and manage costs. Low barriers to entry will attract
new completion while high barriers discourage this. Industry rivalry will be higher when there are
several companies wanting to grab the customers attention. This intense rivalry can lead to lower
prices and profits.
2) State some advantages of the Five Force model.
It enables managers to think about the current situation of their industry in a structured,
understandable manner. This can be used as a starting point for further, deeper analysis. It also
provides the company with a baseline to size up companies strengths and weaknesses. It will show
where the company stands in regards to its buyers, suppliers, entrants, rivals and substitutes. As it
helps in the understanding of the industry structure it will aid in positioning a company as well as look
to understand the average profitability of an industry and how that changes over time.
1.1.4

Industry and sector

The terms industry and sector are often used interchangeably to describe a group of companies that
operate in the same segment of the economy or share a similar business type. Although the terms are
commonly used interchangeably, they do, in fact, have slightly different meanings. This difference
pertains to their scope; a sector refers to a large segment of the economy, while the term industry
describes a much more specific group of companies or businesses.
A sector is one of a few general segments in the economy within which a large group of companies can
be categorized. An economy can be broken down into about a dozen sectors, which can describe nearly
all of the business activity in that economy. For example, the basic materials sector is the segment of the
economy in which companies deal in the business of exploration, processing and selling the basic
materials such as gold, silver or aluminium which are used by other sectors of the economy.
An industry, on the other hand, describes a much more specific grouping of companies with highly similar
business activities. Essentially, industries are created by further breaking down sectors into more defined
groupings. Each of the dozen or so sectors will have a varying number of industries, but it can be in the
hundreds. For example, the financial sector can be broken down into industries such as asset

management, life insurance and Northwest regional banks. The Northwest regional bank industry, which
is part of the financial sector, will only contain companies that operate banks in the North-western states.
When breaking down the economy, the first groups are sectors which describe a general economic
activity. Then all of the companies that fall into that sector are categorized further into industries where
they are grouped only with companies with which they share very similar business activities. This is not
the end, however. Industries can be further sub-categorized into various, more specific groupings.
It should be noted that you may find situations in which these two terms are reversed. However, the
general idea remains: one breaks the economy down into a few general segments while the other further
categorizes those into more specific business activities. In the stock market the generally accepted
terminology cites a sector as a broad classification and an industry as a more specific one.
1.1.5

Government / business relations

Government and business institutions in a country in many ways are interrelated and interdependent on
each other. In todays global economy, its businessmen and entrepreneurs are the driving forces of the
economy. In planned economy or even in market economy government holds control of shaping the
business activates of a country. For maintaining a steady and upward economic growth The Government
must try to make the environment for business organizations suitable. And the organizations must follow
the laws of governments to run the businesses smoothly and making sure there is a level playing field.
The main goal of businesses is to make profit and governments goal is to ensure economic stability and
growth. Both of them are different but very co-dependent. For this the government and organizations or
businesses always tries to influence and persuade each other in many ways for various matters. A
balanced relationship between the government and businesses is required for the welfare of the economy
and the nation.
Lets see how government and business organizations try to influence each other.
How Business Organizations Influences the Government
Organizations try to force the government to act in ways that benefits the business activities. Of course
for that an organization must go through in a legitimate way. But sometimes we see that organizations try
to go over the line. Any ways, these are the common methods that business organizations us to influence
government policies.

Personal Conducts and Lobbying

The corporate executives and political leaders and government officials are in the same social
class. This creates a personal relationship between both parties. Also organizations formally
forms group to present its issues to government bodies.

Forming Trade Unions And Chamber Of Commerce

Trade unions and chamber of commerce are associations of business organizations with
common interest. They work to find the common issues of organizations and present reports,
holds dialogue to discuss on them with government bodies.

Large Investment

The companies if can make a very large investment in industries or projects, them could
somehow effect the government policies. We see these very often in developing countries where
foreign corporates wants to invest in these countries. These works in other way around, where
government tries to implement polices to attract foreign investment.
How Government Influences the Business Organizations
The government attempts to shape the business practices through both directly and indirectly
implementing rules and regulations. The government most often directly influences organizations through
establishing regulations, laws and rules that dictate what organizations can and cannot do. To implement
legislation, the government generally creates special agencies to monitor and control certain aspects of
business activity. For example, environment protection agency handles Central Bank, Food and Drug
Administration, Labor Commission, Securities and Exchange Commission and many more. These
agencies directly creates, implements laws and monitors its application in organization.
Governments sometimes take an indirect approach to shape the activities of business organizations.
These are also done by implementing laws or regulations but they are not always mandatory. For
instance, the government sometimes tries to change organizations polices by their tax codes.
Government could give tax incentives to companies that have an environment friendly waste
management system in production factory. Or, tax incentives could be provided to companies that has
established its production facilities in a less developed region in the country. As a result, more often the
businesses would probably do so. However these regulation and its implementation must be at a optimal
degree.

Relationships with stakeholder

Shifts in economic balance of power