ICAI Notes- Introduction: Business Environment | Business and Commercial Knowledge (Old Scheme) - CA Foundation PDF Download

Learning Outcomes

After studying this chapter, you will be able to:

• Understand the concept of the business environment with its characteristics and importance.
• Understand what is the environmental analysis and why is it needed.
• Know the environmental factors that influence a business.
• Have a basic knowledge of various types of environments.
• Have an understanding of different micro-economic factors that are affecting business.
• Know the various macro-economic factors and how they are related to business.

Introduction

• A business is created to provide products or services to customers. If it can conduct its operations effectively, its owners earn a reasonable return on their investment in the firm. 
• In addition, it creates jobs for employees. Thus, businesses can be beneficial to society in various ways.
• A business (or firm) is an enterprise that provides products or services desired by customers. 
• Along with the large, well-known businesses such as The Coca-Cola Company and IBM, there are many thousands of small businesses that provide employment opportunities and produce products or services that satisfy customers.
• The world keeps changing. It always has and always will. The basic challenge for any company (or, for that matter, for any living thing) is survival. And to survive over the long term, a company must have two capabilities:
  • the ability to prosper and
  • the ability to change

What is most surprising is the amount of change going on around us! And we notice, at the same time, how some organisations change very little.

• Over any time period, say one, five, ten years, in any geographic region thousands upon thousands of new organizations are set up, and within the same time frame many thousands are dissolved, mostly small ones but sometimes very large ones too. 
• An analysis says that approximately, 5,00,00,000 new firms are born every year across the globe or about 1,37,000 per day. And, similar number of firms are close as birth and death rates are about equal, the same number of active firms, say 1,30,000 probably terminate trading each day, worldwide.
• Some organisations go on for a very long time. For instance, the Tata Group whose foundations were laid by Jamsetji Tata has been flourishing since 1868 whereas few commercial organisations have survived for more than a century. On an average, however, the lifespan of commercial organisations in our country is about 50 years.
• Over the years, surviving organisations change their structures as well as the composition of their activities. As they do so they either threaten or create opportunities for others. Whole new industries appear as new technologies are developed, creating niches of new activities for both new and old organisations, while other industries disappear.
• Each business organization operates in its unique environment. Environment influence businesses and also gets influenced by it. No business can function free of interacting and influencing forces that are outside its periphery. 
• In the emerging economy the facets of business are rapidly changing as compared to earlier years. The developments in technology and faster communication have lead to evolvement of newer kinds of businesses. The concept of businesses such as online shopping were non-existent in yesteryears. Businesses are conducted through internet and have lead to virtual shrinking of physical boundaries between nations.

Meaning of Business Environment

The business environment represents all external forces, factors or conditions that exert some degree of impact on the business decisions, strategies and actions taken by the firm. The success of a business is generally dependent on its business environment. A successful business has to identify, appraise, and respond to the various opportunities and threats in its environment. To be successful, the business has to not only recognize different elements of its own environment but also respect/ adapt and manage and influence them. The business must continuously monitor and adapt itself to the environment if it is to survive and prosper.

According to Gluek and Jauch:

“The environment includes factors outside the firm which can lead to opportunities for, or threats to the firm. Although, there are many factors, the most important of the factors are socioeconomic, technological, suppliers, competitors, and government.”

Characteristics of Business Environment

The business environment exhibits many characteristics. Some of the important and obvious characteristics are briefly described here.

Importance of Understanding Business Environment

There is a close and continuous interaction between a business and its environment. This interaction helps in strengthening the business firm and using its resources more effectively. It helps the business in the following ways:

1. Determining Opportunities and Threats: The interaction between the business and its environment would bring out opportunities for and threats to the business.
2. Giving Direction for Growth: The interaction with the environment enables the business to identify the areas for growth and expansion of their activities.
3. Continuous Learning: The managers are motivated to continuously update their knowledge, understanding and skills to meet the predicted changes in the realm of business.
4. Image Building: Environmental understanding helps business organizations in improving their image by showing their sensitivity to the environment in which they operate. For example, in view of the shortage of power, many companies have set up Captive Power Plants (CPPs) in their factories to meet their own requirement of power. 
5. Meeting Competition: It helps the firms to analyze the competitors’ strategies and formulate their own strategies accordingly.

Relationship Between Organisation and its Environment

In relation to the individual corporate enterprise, the external environment offers a range of opportunities, limitations, threats and pressures and thereby influences the structure and functioning of the enterprise.

The relationship between the organization and its environment may be discussed in terms of interactions between them in several major areas which are outlined below:

Exchange of information: 

• The organization scans the external environmental variables, their behaviour and changes, generates important information and uses it for its planning, decision-making and control purposes. 
• Much of the organizational structure and functioning is attuned to the external environmental information. 
• Information generation is one way to get over the problems of uncertainty and complexity of the external environment. Information is to be gathered on economic activity and market conditions, technological developments, social and demographic factors political-governmental policies and postures, the activities of other organizations and so on. 
• Both current and projected information is important for the organization. Apart from gathering information, the organization itself transmits information to several external agencies either voluntarily, inadvertently or legally. Other organizations and individuals may be interested in the organization and its functioning and hence approach the organization for information.

Exchange of resources 

• The organization receives inputs—finance, materials, manpower, equipment etc. from the external environment through contractual and other arrangements. 
• The resources are often categorised as 5 M’s Men, Money, Method, Machine, Material. 
• It sustains itself by employing the above inputs for involving or producing output of products and services. 
• The organization interacts with the factor markets for purposes of getting its inputs; it competes sometimes and collaborates sometimes with other organizations in the process of ensuring a consistent supply of inputs.
• The organization is dependent on the external environment for disposal of its output of products and services to a wide range of clientele. This is also an interaction process perceiving the needs of the external environment and catering to them, satisfying the expectations and demands of the clientele groups, such as customers, employees, shareholders, creditors, suppliers, local community, general public and so on.

Exchange of influence and power

• Another area of organizational-environmental interaction is in the exchange of power and influence. The external environment holds considerable power over the organization both by virtue of its being more inclusive as also by virtue of its command over resources, information and other inputs. 
• It offers a range of opportunities, incentives and rewards on the one hand and a set of constraints, threats and restrictions on the other. In both ways, the organization is conditioned and constrained. The external environment is also in a position to impose its will over the organization and can force it to fall in line.
• Sometimes, organisations are also in position to wield considerable power and influence over some of the elements of the external environment by virtue of its command over resources and information. To the extent that the organization is able to hold power over the environment it increases its autonomy and freedom of action. It can dictate terms to the external forces and mould them to its will.

In defining the relationship between the organization and the environment, one has to be clear on the diversity of both these entities. The nature of relationship depends on the size of the organization, its age, the nature of business, the nature of ownership, degree of professionalization of management, etc.

Organisation’s Response to its Environment

Organizations must have the capacity to monitor and make sense of their environments if they are to respond appropriately. They must identify and attend to those environmental factors and features that are closely related to goal achievement and performance. Moreover, they must have the internal capacity to develop effective responses.
Three classes of responses are described below:

1. Administrative Response: The most common organizational responses to the environment are administrative. These include the formation or clarification of the organization’s mission; the development of objectives, policies, and budgets; or the creation of scanning units. These responses can be either proactive or reactive and are aimed at defining the organization’s purpose and key tasks in relationship to particular environments.
2. Competitive Response: Competitive ressponses to the environment typically are associated with for-profit firms but can also apply to non-profits and governmental organizations. Such actions seek to enhance the organization’s performance by establishing a competitive advantage over its rivals. To sustain competitive advantage, organizations must achieve an external position vis-à-vis their competitors or perform internally in ways that are unique, valuable, and difficult to imitate.
3. Collective Response: Organizations can cope with problems of environmental dependence and uncertainty through increased coordination with other organizations. Collective responses help control interdependencies among organizations and include such methods as bargaining, contracting, co-opting, and creating joint ventures, federations, strategic alliances, and consortia. Contemporary organizations are increasingly turning towards joint ventures and partnerships with other organizationsto manage environmental uncertainty and perform tasks that are too costly and complicated for single organizations to perform.