The business environment is getting more dynamic in recent years. Technology, consumer tastes, and international policies change at a quick pace. The change could bring past competitive advantage to competitive disadvantage, or vice versa. It also forces companies to rethink their competitive strategy.
Definition of the business environment
The business environment refers to the set of conditions or forces that affect the functioning of the business. They may be outside or inside the organization.
Understanding the nature of the business environment and their changes is a vital part of business analysis and in designing competitive strategies. That’s to make sure the company has the right success strategy, not only now but also in the future.
Types of Business Environments
Broadly speaking, the environment in which the business operates consists of two categories, namely:
- Internal environment, which includes various factors under the control of the company.
- External environment, which represents various factors outside the company’s control.
The internal environment consists of organizational structure, corporate culture, and company resources. They are in control of the company. I mean, companies can change them to adapt to the external environment and to achieve goals.
Some experts offer different classifications for the external environment. And, here, I will refer to Thomas L. Wheelen’s book “Strategic Management and Business Policy.” He divides the hierarchy of the external environment into three levels, namely:
- Natural physical environment
- Societal environment
- Task environment
Natural physical environment consists of physical resources, climate, and wildlife. They are the outer environment and affect the other two environments (societal environment and task environment).
Societal environment includes components of PESTEL analysis but excludes environmental factors. So it consists of politics, economy, social culture, and technology factors. Why exclude environmental factors? The reason is, any change in the natural environment can have implications for changes in political and economic, socio-cultural, and technological policies, but not vice versa. For example, global warming pressures affect how governments take economic policies. It also affects the community in adapting to these changes. But, both the government and the people, they cannot influence global temperatures. I mean, we can not lower the global temperature drastically. We just adapt by doing environmentally-friendly activities, reducing the effect on rising global temperatures. For this reason, environmental factors should be at a higher hierarchy (i.e., at point 1).
Task environment covers interactions between the company and its stakeholders. They consist of the government, special interest groups, customers, competitors, trade associations, trade unions, creditors, and the community.
Next, I present some useful analyzes briefly to help you understand the business’s external environment:
- PESTEL analysis
- Industry cycle
- Porter’s Five Forces
- Stakeholder analysis
- Strategic groups
- Key success factors
The PESTEL analysis details the variables of political, economic, socio-cultural, technological, natural, and legal forces that affect business operations. The significance of each variable to companies varies, depending on the type of industry. Interest rates, for example, affect commercial banks more than manufacturers.
The industry cycle tells you what phase the industry is in. The cycle consists of introduction, growth, mature, and decline phases. Each stage has different implications for sales growth, marketing, and competition strategies.
Porter’s Five Forces explains to you why profitability in specific industries is higher than in other sectors. Porter then details the five forces that affect profitability (1) the bargaining power of buyers, (2) the bargaining power of suppliers, (3) the threat of substitution, (4) the threat of new entrants, and (5) rivalry between companies within the industry.
Stakeholder analysis is critical to answering whose interests should be considered when developing or implementing a strategy. You should systematically gather and analyze information about who the company stakeholders are, how they affect the company, and how significant their impact on the company.
Strategic groups help you to identify who is the most direct competitor. Not only that, through this analysis, but you would also know on what basis they are competing.
Key success factors articulate what companies should do and how to do it well. Breaking them down is critical for achieving the goals outlined in the strategic plan.
Why should you understand the business environment?
The business environment affects the success and profitability of the company. Their changes affect the company’s strategic decisions. Some might have indirect direct, while others have a direct impact.
The business environment exposes company performance and strategy. For examples:
- Natural environments such as forest fires, climate change, and natural disasters.
- Political events, such as changes in leadership, corruption, and political unrest.
- Economic conditions, such as a recession, high-interest rates, currency devaluation, and hyperinflation.
- Socio-cultural changes such as changes in consumer tastes and preferences, shifts in demographic composition, and urbanization.
- Changes in regulations, such as competition regulations, product safety, and consumer protection.
- Technologies such as the internet and e-commerce
- Internal conditions, such as employee turnover and productivity.
How big the impact of each factor to the company, it depends on the industry in which it operates. Devaluation will have greater exposure to exporters than property insurance companies. Likewise, shifts in consumer tastes have more impact on food producers than banks.
In most cases, companies have control over the internal environment, but not the external environment. Companies simply only adapt to any changes in the external environment. And, in this case, the uncertainty and magnitude of the effect should be your consideration. The higher their uncertainty and influence, the greater the strategic challenges for the company.
The dynamic external environment is forcing companies to respond quickly and appropriately. Scenario planning, intuition, and learning approach are essential to respond. It also requires a flexible organizational structure so that decisions can be taken quickly.