Business Environment | ISC Class 12 Commerce Notes

This note covers the meaning, features and importance of business environment, environmental scanning, the micro dimensions (internal and external factors) and macro dimensions (economic, social, technological, political and legal) of business environment, and a basic understanding of SWOT analysis.

What is business environment and what are its features?

Business environment means the sum total of all individuals, institutions and other forces that are outside the control of a business enterprise but that may affect its performance.

As one writer put it, "Just take the universe, subtract from it the subset that represents the organisation, and the remainder is environment".

The economic, social, political, technological and legal forces that operate outside a firm, along with consumers, competitors, governments, consumer groups, courts and media, together constitute its environment.

These individuals, institutions and forces are likely to influence the performance of a business enterprise although they exist outside its boundaries.

For example, an increase in taxes by government can make things expensive to buy; technological improvements may render existing products obsolete; political uncertainty may create fear in the minds of investors; changes in fashions and tastes of consumers may shift demand from existing products to new ones; and increased competition may reduce profit margins of firms.

Business environment has several features. It is a totality of external forces, aggregative in nature.

It includes both specific forces (such as investors, customers, competitors and suppliers, which affect an enterprise directly and immediately) and general forces (such as social, political, legal and technological conditions, which affect many firms at once and so affect an individual firm only indirectly).

Its elements show inter-relatedness: for instance, increased life expectancy and health awareness have increased demand for health products such as soft drinks, fat-free cooking oil and health resorts, and these new products have in turn changed people's lifestyles.

Business environment is also dynamic, changing with technological improvement, shifts in consumer preference or new competition; it is largely uncertain, as future happenings are difficult to predict, especially where change is frequent, as in information technology or fashion; it is complex, since numerous interrelated and dynamic conditions arising from different sources make it easier to understand in parts than as a whole; and it shows relativity, differing from country to country and region to region, for example political conditions in the USA differ from those in China or Pakistan, and demand for sarees is high in India but almost non-existent in France.

Definition: Business environment. The sum total of all individuals, institutions and other forces that are outside the control of a business enterprise but that may affect its performance.

Why is understanding the business environment important?

A business firm does not exist in isolation; it exists, survives and grows within the context of its environment.

A firm can do little to change or control these outside forces, so it has no alternative but to respond or adapt to them. Understanding the environment is important for several reasons.

1. It enables the firm to identify opportunities (positive external trends that help improve performance) and gain the first mover advantage by exploiting them before competitors. For example, Maruti Udyog became the leader in the small car market because it was the first to recognise the need for small cars in an environment of rising petroleum prices and a large middle class population in India.
2. It helps the firm identify threats (external trends that hinder performance) and early warning signals, for example if a foreign multinational enters the Indian market with new substitutes, giving Indian firms time to improve quality, reduce costs or advertise more aggressively.
3. It helps in tapping useful resources such as finance, machines, raw materials, power, water and labour, which an enterprise draws from its environment including financiers, government and suppliers, in exchange for goods, services, taxes and returns.
4. It helps in coping with rapid changes, since turbulent market conditions, less brand loyalty, fragmentation of markets, demanding customers and intense global competition mark today's environment.
5. It assists in planning and policy formulation, since understanding both opportunities and threats forms the basis for deciding future courses of action.
6. It helps in improving performance, as enterprises that continuously monitor their environment and adopt suitable practices tend to succeed over a longer period.

What is environmental scanning?

Environmental scanning is the continuous process of monitoring, tracking and analysing the forces in a firm's external environment, so that management can keep itself informed of trends, events and relationships that may affect how the firm performs and decides its strategy.

Because business environment keeps changing in terms of technology, consumer preference and competition, management cannot afford to study it only once; it must keep scanning the environment regularly to spot opportunities early and to receive warning of threats in good time.

Environmental scanning thus links directly to the importance of environment discussed above: a firm that scans its environment well is able to identify opportunities for a first mover advantage, pick up early warning signals of threats, and adjust its planning and policy before a competitor does so.

It also helps managers decide which forces matter most to their particular business, since not every economic, social, technological, political or legal change affects every firm equally, and a firm with limited resources must prioritise the signals that scanning throws up.

Definition: Environmental scanning. The ongoing process by which management monitors and analyses the forces of the external environment to identify opportunities and threats that may affect the firm's performance and strategy in time.

What are the dimensions of business environment?

The dimensions, or factors, of business environment are usually grouped under two broad heads: the micro environment, made up of forces close to the firm that affect it directly and specifically, and the macro environment, made up of broader general forces that affect many enterprises at the same time.

Specific forces such as investors, customers, competitors and suppliers affect individual enterprises directly and immediately in day-to-day working, while general forces such as social, political, legal and technological conditions have an impact on all business enterprises and so affect a firm only indirectly.

Micro environment: internal factors

The internal factors of the micro environment are forces within the firm's own boundaries that management can largely control or shape, such as its value system, mission and objectives, managerial structure and internal power relationships, human resources, company image and brand equity, and its physical and financial resources.

These internal factors decide how well a firm can respond to the external forces around it; a firm with strong human resources and a clear mission is better placed to exploit an opportunity or meet a threat than one without.

Micro environment: external factors

The external factors of the micro environment are forces just outside the firm that still influence it directly in its day-to-day working, for example its customers, competitors and suppliers.

Because these forces act on an individual enterprise specifically rather than on business in general, they are also called specific forces, and a firm must track them closely since a change among them, such as a key supplier raising prices or a new competitor entering the market, affects the firm almost at once.

Macro environment

The macro environment consists of general forces that act on many enterprises at the same time rather than on one firm alone. It has five recognised components: economic, social, technological, political and legal environment, each discussed below.

How does each macro factor affect business?

The economic environment affects demand and cost directly. Short and long-term interest rates significantly affect demand for products and services; for construction companies and automobile manufacturers, low long-term rates are beneficial because they encourage people to borrow money to buy homes and cars.

A rise in disposable income due to a rise in gross domestic product creates increasing demand for products, while high inflation rates generally constrain business by raising the cost of raw materials, machinery, wages and salaries.

The social environment includes customs, traditions, values and social trends. For example, the celebration of Diwali, Eid, Christmas and Guru Parv in India creates significant financial opportunities for greetings card companies, sweet and confectionery manufacturers, tailoring outlets and related businesses.

Values such as individual freedom, social justice, equality of opportunity and national integration translate into freedom of choice in the market and non-discriminatory employment practices.

Social trends also open opportunities, for example the health-and-fitness trend among urban dwellers has created demand for organic food, gyms, bottled water and food supplements.

The technological environment covers scientific improvements and innovations that create new ways of producing goods and services and new methods of operating a business; advances in computers and electronics have changed how companies advertise, how retailers link with suppliers, and how customers book flight tickets online.

The political environment covers political stability and peace and the attitude of elected representatives towards business. Political stability builds confidence among business people to invest in long-term projects, while political instability or threats to law and order can shake that confidence and create uncertainty.

The legal environment covers legislations, administrative orders, court judgments and decisions by commissions and agencies at the central, state or local level.

It is important for every enterprise to obey the law of the land, and non-compliance can land a business in legal problems; for example, advertisements of alcoholic beverages are prohibited, cigarette packets must carry the statutory warning that smoking is injurious to health, and advertisements of baby food must inform buyers that mother's milk is best.

Acts that form part of the legal environment

In India, a business must be aware of the Constitutional provisions and of enactments such as the Companies Act, 2013, the Industries (Development and Regulation) Act, 1951, the Foreign Exchange Management Act, 1999, the Consumer Protection Act, 2019, the Information Technology Act, 2000 and the Competition Act, 2002, together with the labour laws on factories, trade unions, industrial disputes and workers' compensation, as amended or replaced from time to time by Parliament.

What is SWOT analysis?

SWOT analysis is a basic technique that helps a firm study its environment by listing its strengths, weaknesses, opportunities and threats.

Strengths and weaknesses are internal to the firm, found within its own resources, capabilities and ways of working, while opportunities and threats arise from the external environment, the same kind of forces discussed under the micro and macro dimensions above.

A firm carries out a SWOT analysis to match its internal strengths against external opportunities, and to be aware of its internal weaknesses and the external threats that could expose them, so that it can plan sensibly rather than react to events as they occur.

Definition: SWOT analysis. A basic technique of listing a firm's internal Strengths and Weaknesses together with external Opportunities and Threats, to understand how the firm is placed to act on its business environment.

Merits of SWOT analysis

SWOT analysis gives management a simple, organised way of putting internal and external factors side by side, so it is easy to grasp.

By identifying strengths early, a firm can plan to use them for a first mover advantage, and by identifying weaknesses it can work to correct them before they are exposed by a threat.

Because it links the internal and external dimensions of environment in one picture, SWOT analysis supports planning and policy formulation, and it helps managers set priorities when deciding which opportunities to chase and which threats to guard against first.

Limitations of SWOT analysis

SWOT analysis is only as good as the honesty and accuracy of the list drawn up; a firm may overstate its strengths or understate its weaknesses.

It gives a static picture at one point in time, whereas business environment is dynamic and uncertain, so a SWOT list can quickly become outdated.

It does not by itself rank the items in order of importance or tell a firm exactly what action to take, it simply lays out the factors for managers to weigh and interpret.

Going beyond the syllabus

The same five macro dimensions, economic, social, technological, political and legal, are used by businesses everywhere to scan markets outside their own country, since relativity means these forces differ from one country or region to another.

A firm expanding abroad would typically repeat the same environmental scan and a fresh SWOT analysis for the new market, since strengths and opportunities that work in one country may not transfer directly to another.

Glossary

• Business environment — the sum total of individuals, institutions and other forces outside a firm's control that may affect its performance.
• Environmental scanning — the continuous process of monitoring external forces to identify opportunities and threats in time.
• Micro environment — forces close to a firm, internal or just outside it, that affect it directly and specifically.
• Macro environment — broad general forces, economic, social, technological, political and legal, that affect many enterprises at once.
• Internal factors — forces within a firm's own boundaries, such as its value system, management structure and resources.
• External factors — forces just outside a firm, such as customers, competitors and suppliers, that act on it directly.
• Specific forces — forces, like investors or suppliers, that affect an individual enterprise directly and immediately.
• General forces — forces, like social or legal conditions, that affect many enterprises and so act on one firm only indirectly.
• Opportunities — positive external trends or changes that help a firm improve its performance.
• Threats — external trends or changes that hinder a firm's performance.
• First mover advantage — the benefit a firm gains by being the first to exploit an opportunity before competitors do.
• SWOT analysis — listing a firm's internal Strengths and Weaknesses together with external Opportunities and Threats.
• Strengths — internal resources or capabilities that give a firm an advantage over rivals.
• Weaknesses — internal limitations that put a firm at a disadvantage.
• Relativity (of environment) — the idea that business environment differs from country to country and region to region.

Common errors and misconceptions

• Misconception: Business environment only means the economic conditions of a country. Correct: It is the sum total of all outside forces, economic, social, technological, political and legal, as well as specific forces like investors and suppliers.
• Misconception: A firm can control its business environment if it is large enough. Correct: An individual firm can do little to change or control environmental forces; it can only respond or adapt to them.
• Misconception: Micro and macro environment mean the same thing. Correct: Micro environment covers internal and immediate external factors specific to one firm, while macro environment covers general forces that affect many firms together.
• Misconception: Strengths and weaknesses in SWOT come from outside the firm. Correct: Strengths and weaknesses are internal to the firm; only opportunities and threats come from the external environment.
• Misconception: Environmental scanning is a one-time study done before launching a business. Correct: It is a continuous process, since business environment is dynamic and keeps changing.
• Misconception: General forces affect every firm in exactly the same way. Correct: General forces affect many firms at once, but their impact on an individual firm is indirect and may differ in degree.
• Misconception: Legal environment means only Acts passed by Parliament. Correct: It also includes administrative orders, court judgments and decisions of commissions and agencies at central, state or local level.

Exam-style questions with model answers

Q1. State what is meant by business environment. [1 mark]

1. Business environment means the sum total of all individuals, institutions and other forces outside a business enterprise's control that may affect its performance.

Q2. Name the two broad forces into which business environment is divided, and give one example of each. [2 marks]

1. Specific forces, which affect an individual firm directly, for example a supplier or competitor.
2. General forces, which affect many firms indirectly, for example the political or legal environment.

Q3. Ambar Ltd. is a textile firm. Over the past year, its promoters noticed that a change in government import duty on cotton yarn raised its cost of raw material, while a rival firm launched a cheaper synthetic alternative that attracted many of Ambar Ltd.'s customers. State which two dimensions of business environment are illustrated here, and explain each with reference to the case. [4 marks]

1. The economic environment is illustrated by the change in import duty on cotton yarn, which raised Ambar Ltd.'s raw material cost, since the economic environment includes government policy effects on the cost of inputs such as raw materials.
2. Competition from the rival firm's synthetic alternative is an example of a specific (micro environment) force, since a competitor acts directly and immediately on an individual enterprise rather than on business in general.
3. Together, the case shows that a firm faces both general economic forces, which change the cost side of its business, and specific competitive forces, which change the demand side, at the same time.

Q4. Explain the feature of "relativity" of business environment, with one example. [3 marks]

1. Relativity means business environment is a relative concept; it differs from country to country and even from region to region within the same country.
2. For example, political conditions in the USA differ from those in China or Pakistan.
3. Similarly, demand for sarees is fairly high in India but almost non-existent in France, so the same product faces a different environment in different places.

Q5. Priya runs a chain of gyms in a city where urban residents have grown increasingly health conscious over the last five years, leading to higher demand for memberships, protein supplements and organic food outlets nearby. Identify the dimension of business environment illustrated, and explain how this dimension can create opportunities for a firm. [4 marks]

1. The social environment is illustrated here, since it includes social trends and society's expectations, and the case shows a health-and-fitness trend among urban dwellers.
2. Social trends such as this one create demand for related products and services, for example organic food, gyms and food supplements.
3. Early identification of such a trend lets a firm such as Priya's gym chain expand its offerings, such as adding a supplements counter, ahead of competitors.
4. This shows how understanding the social environment helps a firm identify opportunities and gain a first mover advantage over rivals who notice the trend later.

Q6. Distinguish between the internal and external factors of the micro environment of business. [4 marks]

1. Internal factors lie within the firm's own boundaries, such as its value system, mission and objectives, managerial structure, human resources, company image and physical and financial resources, and are largely within management's own control.
2. External factors of the micro environment lie just outside the firm but affect it directly, such as its customers, competitors and suppliers.
3. Internal factors decide how well a firm can respond to outside forces, while external factors are the specific forces to which the firm must respond.
4. Both together make up the micro environment, as distinct from the macro environment, which consists of general forces affecting many firms together.

Q7. Explain, with reference to a basic SWOT analysis, why strengths and weaknesses are classed differently from opportunities and threats. [5 marks]

1. SWOT analysis lists a firm's Strengths, Weaknesses, Opportunities and Threats so that both internal and external factors are examined together.
2. Strengths and weaknesses arise from inside the firm, from its own resources, capabilities and ways of working, and are things the firm can, in principle, change or improve through its own effort.
3. Opportunities and threats arise from the external environment, the same economic, social, technological, political and legal forces, and specific forces such as competitors, that a firm cannot directly control.
4. Keeping the two types separate helps a firm see clearly which problems it can fix internally, such as a weak managerial structure, and which forces it can only respond or adapt to, such as a competitor's new product.
5. This separation is a merit of SWOT analysis, since it organises information for planning, though it remains a limitation that SWOT does not by itself rank which factor matters most or prescribe the exact action to take.

Q8. "A firm cannot ignore its business environment even though it cannot control it." Explain this statement with any three points on the importance of business environment. [6 marks]

1. A business firm does not exist in isolation; it exists, survives and grows within its environment, and while it can do little to change or control external forces, it must respond or adapt to them.
2. Understanding the environment enables a firm to identify opportunities early and gain a first mover advantage, as seen in a firm that recognises rising demand for a product category before its rivals do.
3. It also helps a firm identify threats and early warning signals in time, for example the entry of a new competitor with a substitute product, so that the firm can improve quality, cut costs or advertise more strongly in response.
4. Understanding the environment helps a firm tap the resources it needs, such as finance, raw materials and labour, from outside, since the firm depends on its environment both as a source of inputs and as an outlet for its outputs.
5. Finally, awareness of environment assists planning and policy formulation and tends to improve a firm's performance over time, since firms that continuously monitor their environment and adapt their practices are more likely to succeed over a longer period.

Key takeaways

• Business environment is the sum total of forces outside a firm's control that may affect its performance.
• Its features are totality of external forces, specific and general forces, inter-relatedness, dynamic nature, uncertainty, complexity and relativity.
• Understanding environment helps a firm spot opportunities for a first mover advantage and threats as early warning signals.
• It also helps a firm tap resources, cope with rapid change, plan and set policy, and improve performance.
• The micro environment has internal factors, within the firm, and external factors, such as customers, competitors and suppliers, just outside it.
• The macro environment has five components: economic, social, technological, political and legal.
• Legal environment includes Acts such as the Companies Act, 2013 and the Consumer Protection Act, 2019, among others.
• Environmental scanning is the continuous monitoring of the environment to pick up opportunities and threats in time.
• SWOT analysis lists internal Strengths and Weaknesses alongside external Opportunities and Threats.
• SWOT analysis is simple and organised but gives only a static picture and does not itself rank priorities.

Test yourself

What does the "relativity" feature of business environment mean?

It means business environment differs from country to country and region to region, so the same factor can have different effects in different places.

Give one example of a specific force and one example of a general force in business environment.

A supplier or competitor is a specific force, affecting a firm directly; the political or legal environment is a general force, affecting many firms indirectly.

Why is environmental scanning described as a continuous process rather than a one-time exercise?

Because business environment is dynamic and uncertain, trends and conditions keep changing, so management must keep monitoring them rather than study them only once.

Which two elements of SWOT are internal to a firm, and which two are external?

Strengths and Weaknesses are internal to the firm; Opportunities and Threats arise from its external environment.

Name the five components of the macro environment of business.

Economic, social, technological, political and legal environment.

State one limitation of SWOT analysis.

It gives a static picture at one point in time and does not itself rank which factor is most important or prescribe exact action.

Why can a firm not control its business environment but must still study it?

Because environmental forces lie outside the firm's boundaries, a firm can only respond or adapt to them, and ignoring them risks missed opportunities or unseen threats.