A business can't operate on its own. Outside the office walls, there are multiple factors that can dictate its performance. Some examples include new technology and changes in taxes, interest rates, or minimum wages. In business terms, these are called external factors. Read on to find out how external factors influence business and how companies can adapt to the ever-changing external environment.
External factors affecting the business meaning
There are two types of factors influencing business decisions: internal and external. Internal factors are elements that come from within or are under a company's control, e.g. human resources, organisational structure, corporate culture, etc. External factors, on the other hand, are elements that come from outside, e.g. competition, new technology, and government policies.
External factors are elements from outside the company that affect business performance, such as competition, economic climate, political and legal environment, technological advances, or major global events.
External factors affecting business
There are five main types of external factors affecting business:
Political
Economic
Social
Technological
Environmental
Competitive.
Use the acronym PESTEC to memorise this better!
Figure 1. Business External Factors - StudySmarter
External factors can have both positive and negative impacts on business operations. To sustain profitable growth, companies need to constantly monitor environmental changes to adapt and minimise their negative consequences.
Political factors affecting business
Political influence on business refers to new legislation that affects consumers', employees, and businesses' rights.
Some examples of business-related legislation include:
Anti-discrimination
Intellectual property
Minimum wage
Health and safety
Competiton
Consumer protection.
Generally, these are grouped into three categories:
Consumer laws - These are laws that ensure businesses will provide consumers with quality goods and services.
Employment laws - These are laws that protect employee rights and regulate the relationship between employees and consumers.
Intellectual property law - These are laws that protect creative work within the business world, e.g. copyrights of music, books, films, and software.
Figure 2. Types of business laws - StudySmarter
Economic factors affecting business
Businesses and the economy have a mutual relationship. The success of businesses results in a healthier economy, whereas a strong economy allows businesses to grow faster. Thus, any changes in the economy will have a significant impact on business development.
Economic activities can deeply be affected by changes in:
Tax rates
Unemployment
Interest rates
Inflation.
One measure of economic performance is aggregate demand. Aggregate demand is the total demand for goods and services within an economy (including consumer and government spending, investing, and exports, minus imports). The higher the aggregate demand, the more robust an economy is. However, too much demand can lead to high inflation, resulting in higher prices for consumers.
Changes in tax, interest rates, and inflation can result in a rise or fall in aggregate demand, which affects economic activity. For example, with lower taxes, individuals and households have more income at their disposal to spend on goods and services. This contributes to higher demand, resulting in more production and jobs created. As a result, business activities grow and the economy flourishes.
Social factors affecting business
Social factors affecting business refer to changes in consumer tastes, behaviour, or attitude that might affect business sales and revenues. For example, nowadays, consumers are paying more attention to environmental issues such as climate change and pollution. This puts pressure on firms to adopt eco-friendly solutions to their production and waste disposal.
Social influence also includes the ethical side of a business, such as how a company treats its employees, consumers, and suppliers.
An ethical business is one that considers the needs of all shareholders, not just owners. Typically, business ethics comprise three main aspects:
Employees - Ensure work-life balance as well as the physical and emotional well-being of the employees.
Suppliers - Stick to the agreed contract and pay suppliers in a timely fashion.
Customers - Provide quality products at a fair price. Businesses should not lie to consumers or sell products that do serious harm to consumers.
In a perfect world, companies would comply with all ethical policies and contribute to the betterment of society. However, in reality, this is unlikely to happen, as ethics tend to be at the opposite end of profitability. For example, a company that paid everyone a living wage might end up with lower profits.
Technological factors affecting business
Technology is used extensively in modern business, from production to product selling and customer support. Technology allows a company to save time and labour costs while achieving more efficiency, which, in the long run, can result in a competitive advantage.
Three key areas of technology in business are automation, e-commerce, and digital media.
Figure 3. Areas of technology that impact business - StudySmarter
Automation is the use of robots to perform repetitive tasks formerly done by humans.
Automation is applied throughout the supply chain of many industries, including electronics manufacturing, automotive, retail, online services, banks, etc.
The manufacturing of cars and trucks is carried out by big, automated robots instead of human workers. These robots can perform a wide range of tasks including welding, assembling, and painting. With automation, production becomes safer, more efficient and more accurate. Companies can hire fewer workers for menial work and focus more on quality-improving activities.
In addition to automation, there is a trend towards e-commerce.
E-commerce is the buying and selling of goods and services on the internet.
Many companies set up an e-commerce shop to accompany their brick-and-mortar stores, while others operate 100% online.
Some examples of e-commerce include:
The key incentive for businesses to move online is to reduce fixed costs. While physical businesses have to pay healthy monthly fees for rent, warehousing, and electricity on-site, an online business pays little to no fixed costs.
For example, an Etsy shop selling cooking recipes and printables can avoid costs of warehousing, hiring workers to work on-site, and renting out a location. Without the burden of fixed costs, the business owner can focus more on product development and promotion.
Finally, there is the extensive use of digital media.
Digital media are online channels that get businesses in contact with their customers.
Some examples include websites, blogs, videos, Google ads, Facebook ads, emails, social media, etc.
While traditional marketing methods like billboards and banners are restricted to local areas, online channels allow companies to communicate their marketing messages across the globe in a matter of seconds.
Environmental factors affecting business
Environmental influence refers to changes in the natural world, such as weather conditions, that might affect business operations.
The production of goods and services is the major cause of climate change, pollution, and waste. For example, the generation of electricity in coal-fired plants releases a tremendous amount of carbon dioxide into the atmosphere, which causes global warming and acid rain. The fashion industry is another CO2 emitter, contributing to around 8-10% of the total greenhouse gas emission each year.
The good news is that many companies nowadays have been adopting eco-friendly solutions to mitigate their impacts on the environment. Some examples include:
Recycling packaging
Offsetting carbon footprint
Introducing energy-saving plans
Adopting more energy-efficient equipment
Switching to fair-trade suppliers.
Competitive factors affecting business
Competitive influence refers to the impact of competition in the business environment. The impact can come from changes in price, product, or business strategy. For example, if a company selling similar products at a similar price to your business suddenly drops its price to attract more customers, you may have to reduce the price as well or risk losing customers.
To avoid the impact of competitive influence, a company can develop competitive advantages. These are attributes that allow the company to outperform its rivals. A business can gain a competitive advantage by investing in a high-quality labour force, exceptional customer support, stellar products, extra services, or a reputable brand image.
The competitive advantage of Starbucks is that it is a global company with strong brand recognition, premium product quality, and a cosy environment that makes customers feel at home. Starbucks is not only a coffee store but a place where you hang out and have a good time with friends and family.
How do changes in the external environment affect business?
In the modern world, external factors are changing at a rapid rate, causing competition to become more intense than ever. Businesses that underestimate competition or are too slow to adapt will get replaced by more innovative firms.
Changes in the external environment are often caused by:
A shift in consumer behaviour
Introduction of new technology
Entry of new competition
An unpredictable event such as war, economic crisis, global pandemic, etc.
Adoption of new legislation, e.g. tax policy, minimum wage.
Before 2007, the world was oblivious to the 'swipe and touch' device, as the mobile phone industry was dominated by Nokia. The introduction of touch screens by Apple changed all of this. Nowadays, most people own a smartphone and spend countless hours communicating, working, and entertaining via their mobile devices. The increased mobile usage also forces companies to adapt sales and marketing tactics to be more mobile-friendly.
Changes in the external environment bring both opportunities and challenges for businesses.
For example, the emergence of online marketing channels such as Facebook and Google ads allows businesses to market and sell their products more effectively. However, their competitors will also have access to the exact same tools and customer base.
To gain a competitive advantage, businesses cannot rely solely on external technology. They need to invest in their own assets such as internal databases, human resources, and intellectual property.
Another way to gain this advantage is to become more socially responsible.
With the external environment changing and the business landscape being taken over by technology, businesses stand a better chance if they are seen in a positive light. This does not mean companies should put on a show. Instead, they should put in a genuine effort to better society.
Some CSR activities include reducing carbon footprint, allocating part of the profit to developing economies, purchasing eco-friendly materials, and improving labour policies.
Starbucks's CSR: Starbucks aims to create a positive impact on the communities it works with by partnering with local non-profit organisations. For each partner, Starbucks donates $0.05 to $0.15 per transaction. The company also provides jobs for veterans and military workers while emphasising diversity and inclusion in the workplace.
As you can see, there are many external factors influencing businesses operations, including globalisation, technological, ethical, environmental, economic, and legal influences. These factors are changing all the time, and to survive, businesses must adapt and react to these changes. Failing to do so will put them at the risk of losing customers and closing down.
External factors affecting business decisions - Key takeaways
- External factors are factors from outside that affect a business's performance, such as economic climate, political and legal environment or technological advances.
- There are five main types of external factors affecting business:
- Political factors
- Economic factors
- Social factors
- Technological factors
- Environmental factors
- Competitive factors.
- External factors are changing the business landscape at an accelerating rate, and companies that fail to keep up will end up getting replaced by others.
- To manage changes in the external environment more efficiently, companies should invest in their internal resources and corporate social responsibility (CSR).
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