MT 534: BUSINESS ENVIRONMENT. What is Business Environment?

MT 534: BUSINESS ENVIRONMENT What is Business Environment? The term Business Environment is composed of two words Business and Environment. In simple terms, the state in which a person remains busy is known as Business. The word Business in its economic sense means human activities like production, extraction or purchase or sales of goods that are performed for earning profits. On the other hand, the word Environment refers to the aspects of surroundings. Therefore, Business Environment may be defined as a set of conditions Social, Legal, Economical, Political or Institutional that are uncontrollable in nature and affects the functioning of organization. Business Environment has two components: 1. Internal Environment 2. External Environment Internal Environment: It includes 5 Ms i.e. man, material, money, machinery and management, usually within the control of business. Business can make changes in these factors according to the change in the functioning of enterprise. External Environment: Those factors which are beyond the control of business enterprise are included in external environment. These factors are: Government and Legal factors, Geo- Physical Factors, Political Factors, Socio-Cultural Factors, Demo-Graphical factors etc. It is of two Types: (a) Micro/Operating Environment (b) Macro/General Environment (a) Micro/Operating Environment: The environment which is close to business and affects its capacity to work is known as Micro or Operating Environment. It consists of Suppliers, Customers, Market Intermediaries, Competitors and Public. (1) Suppliers: They are the persons who supply raw material and required components to the company. They must be reliable and business must have multiple suppliers i.e. they should not depend upon only one supplier. 1

(2) Customers: - Customers are regarded as the king of the market. Success of every business depends upon the level of their customer s satisfaction. Types of Customers: (i) Wholesalers (ii) Retailers (iii) Industries (iv) Government and Other Institutions (v) Foreigners (3) Market Intermediaries: - They work as a link between business and final consumers. Types:- (i) Middleman (ii) Marketing Agencies (iii) Financial Intermediaries (iv) Physical Intermediaries (4) Competitors: - Every move of the competitors affects the business. Business has to adjust itself according to the strategies of the Competitors. (5) Public: - Any group who has actual interest in business enterprise is termed as public e.g. media and local public. They may be the users or non-users of the product. (b) Macro/General Environment: It includes factors that create opportunities and threats to business units. Following are the elements of Macro Environment: (1) Economic Environment: - It is very complex and dynamic in nature that keeps on changing with the change in policies or political situations. It has three elements: (i) Economic Conditions of Public (ii) Economic Policies of the country (iii)economic System (iv) Other Economic Factors: Infrastructural Facilities, Banking, Insurance companies, money markets, capital markets etc. (2) Non-Economic Environment: - Following are included in non-economic environment: (i) Political Environment: - It affects different business units extensively. Components: (a) Political Belief of Government 2

(b) Political Strength of the Country (c) Relation with other countries (d) Defence and Military Policies (e) Centre State Relationship in the Country (f) Thinking Opposition Parties towards Business Unit (ii) Socio-Cultural Environment: - Influence exercised by social and cultural factors, not within the control of business, is known as Socio-Cultural Environment. These factors include: attitude of people to work, family system, caste system, religion, education, marriage etc. (iii) Technological Environment: - A systematic application of scientific knowledge to practical task is known as technology. Everyday there has been vast changes in products, services, lifestyles and living conditions, these changes must be analysed by every business unit and should adapt these changes. (iv) Natural Environment: - It includes natural resources, weather, climatic conditions, port facilities, topographical factors such as soil, sea, rivers, rainfall etc. Every business unit must look for these factors before choosing the location for their business. (v) Demographic Environment :- It is a study of perspective of population i.e. its size, standard of living, growth rate, age-sex composition, family size, income level (upper level, middle level and lower level), education level etc. Every business unit must see these features of population and recognize their various needs and produce accordingly. (vi) International Environment: - It is particularly important for industries directly depending on import or exports. The factors that affect the business are: Globalization, Liberalization, foreign business policies, cultural exchange. Characteristics of the Business Environment 1. Business environment is compound in nature. 2. Business environment is a constantly changing process. 3. Business environment is different for different business units. 3

4. It has both long term and short term impacts. 5. It has unlimited influence of external environment factors. 6. It is very uncertain since it is very difficult to predict future happenings. 7. It has inter-related components. 8. It includes both internal and external environment. Review of the External Environment (in brief) A business does not function in a vacuum. It has to act and react to what happens outside the factory and office walls. These factors that happen outside the business are known as external factors or influences. These will affect the main internal functions of the business and possibly the objectives of the business and its strategies. Main Factors The main factor that affects most business is the degree of competition how fiercely other businesses compete with the products that another business makes. The other factors that can affect the business are: (i) Social how consumers, households and communities behave and their beliefs. For instance, changes in attitude towards health, or a greater number of pensioners in a population. (ii) Legal the way in which legislation in society affects the business. E.g. changes in employment laws on working hours. (iii) Economic how the economy affects a business in terms of taxation, government spending, general demand, interest rates, exchange rates other and global economic factors. 4

(iv) Political how changes in government policy might affect the business e.g. a decision to subsidize building new houses in an area could be good for a local brick works. (v) Technological how the rapid pace of change in production processes and product innovation affect a business. (vi) Ethical what is regarded as morally right or wrong for a business to do. For instance should it trade with countries which have a poor record on human rights. Changing External Environment Markets are changing all the time. It does depend on the type of product the business produces, however a business needs to react or lose customers. Some of the main reasons why markets change rapidly are: (i) Customers develop new needs and wants. (ii) New competitors enter the market. (iii) New technologies mean that new products can be made. (iv) A world or countrywide event happens e.g. Gulf War or foot and mouth disease. (v) Government introduces new legislation e.g. increases minimum wage. Business and Competition Though a business does not want competition from other businesses, inevitably most will face a degree of competition. The amount and type of competition depends on the market the business operates in. For example, (i) Many small rival businesses e.g. a shopping mall or city centre arcade close rivalry. (ii) A few large rival firms e.g. washing powder or Coke and Pepsi. (iii) A rapidly changing market e.g. where the technology is being developed very quickly the mobile phone market. A business could react to an increase in competition (e.g. a launch of rival product) in the following ways: (i) Cut prices (but can reduce profits) 5

(ii) Improve quality (but increases costs) (iii) Spend more on promotion (e.g. do more advertising, increase brand loyalty; but costs money) (iv) Cut costs, e.g. use cheaper materials, make some workers redundant Social Environment and Responsibility Social change is when the people in the community adjust their attitudes to way they live. Businesses will need to adjust their products to meet these changes, e.g. taking sugar out of children s drinks, because parents feel their children are having too much sugar in their diets. The business also needs to be aware of their social responsibilities. These are the way they act towards the different parts of society that they come into contact with. Legislation covers a number of the areas of responsibility that a business has with its customers, employees and other businesses. It is also important to consider the effects a business can have on the local community. These are known as the social benefits and social costs. A social benefit is where a business action leads to benefits above and beyond the direct benefits to the business and/or customer. For example, the building of an attractive new factory provides employment opportunities to the local community. A social cost is where the action has the reverse effect there are costs imposed on the rest of society, for instance pollution. These extra benefits and costs are distinguished from the private benefits and costs directly attributable to the business. These extra cost and benefits are known as externalities external costs and benefits. Governments encourage social benefits through the use of subsidies and grants (e.g. regional assistance for undeveloped areas). They also discourage social costs with fines, taxes and legislation. Pressure groups will also discourage social costs. Why study the business environment? 6

Organizations operate in a pluralistic society where its various claimants with divergent goals seek optimal and benefits from the organizations. But the economics on which businesses operate make the organization dependent on these claimants. As a result each has an impact on the other group but not inordinate powers. This would imply that the business strategy initiated by the organization should hold well throughout the lifetime of the organization. But we see that the case is otherwise. The manner in which businesses are managed differs from region to region and from industry to industry. Organizations irrespective of the country they operate in are forced to re-examine their strategies from time to time. The reasons for this are the various factors and forces, many a time beyond the control of the organizations that they exist in the environment in which the business operates. That is, there is every indication that the pace of change in most organizations business environment is speeding up and it is therefore increasingly important for organizations to have in place systems for monitoring their environment and just as important, for responding appropriately to such change. There is evidence that successful organizations are not so much those that deliver value to customers today, but those that understand how definitions of value are likely to change in the future. Therefore, the importances of Business Environment are: 1. Firm to identify opportunities and getting the first mover advantages: Early identification of opportunities helps the enterprise to be the first to exploit them instead of losing them to 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 India. 2. Firm to identify threats and early warning signals: If a firm finds that a foreign multinational is entering the market, it should give a warning signal and firms can meet the threat by adopting or improving the quality of the product, reducing cost of production, engaging in aggressive advertising, and so on. 3. Coping with rapid changes: All sizes and all types of enterprises are facing increasingly dynamic environment. In order to effectively cope with these significant changes, managers must understand and examine the environment and develop suitable course of action. 7

4. Improving performance: The enterprises that continuously monitor their environment and adopt suitable practices are the ones which not only improve their present performance but also continue to succeed in the market for a longer period. Types of Business Organization Why do organizations exist? The main reason is that some form of value creation can be carried out much more efficiently within the organization than by individuals acting alone. Business organizations are extremely diverse in their forms and functions, even within a single business sector. It is therefore difficult to define an ideal organization. Instead all organizational forms have advantages and disadvantages relative to the environment in which they operate, and successful organizations capitalize on their advantages while recognizing their disadvantages. Thus, businesses need to understand the diversity of organizational types for a number of reasons: (i) (ii) (iii) Different types of organizations will be able to address their customers, suppliers and employees in different ways. Lack of resources could, for example inhibit the development of expensive new products by a small business. As a seller of materials to companies involved in further manufacture, a company should understand how the buying behaviour of different kinds of organizations varies. A small business is likely to buy equipment in a different way to a large public sector. We should be interested in the structure of business units at macroeconomic level. Economists argue that a thriving small business sector is essential for an expanding economy, and that the effect of domination by large organizations may be to reduce competition and innovation. Classification of business organizations There many approaches to classifying organizations that would satisfy the interests identified above. Organizations are commonly classified according to their: 8

(i) (ii) (iii) (iv) size (e.g. turnover, assets, employees, geographical coverage) ownership (e.g. public, private, cooperative) legal form (e.g. sole trader, limited company) industry sector A good starting point of classifying business organizations is to look at their legal form. A business s legal form is closely related to its size, objectives and the level of resources it has available for marketing and for new product development. The main types of business organization are illustrated in the chart below: Types of business organization in the private sector: (i) Typical sole traders include tradesmen such as plumbers, electricians, television repair people etc. Nowadays lots of people are setting up their own businesses by creating small web-based companies working from home. (ii) Partnerships are typically found in professional services such as accountants, solicitors, doctors, dentists etc, where the partners can share expertise and skills. They can also share the workload, organizing work rosters to allow for time off and holidays. Partners also pool their 9

capital. (iii) Companies are owned by shareholders that each contributes a stock of money into a central pool. This pool of capital is then used to provide a core sum of finance, which is then added to by borrowing and other forms of finance. Directors run the company on behalf of shareholders who receive a share of the profits as dividends. (iv) Franchises are licensing arrangements whereby an individual or group can buy the right to trade and produce under a well known brand name in a given locality. The franchisee benefits from working for themselves while having the privilege and reputation associated with a much larger group. Coca-Cola franchises some of its bottling operations, and you will all be familiar with McDonald's. Many of the McDonald's outlets are franchised. In the United States almost half of all retail sales are made through firms operating under the franchise system like McDonald's which has a brand franchise. Franchising is becoming increasingly popular in this country. Franchising is really the 'hiring out' or licensing of the use of 'good ideas' to other companies. A franchise grants permission to sell a product and trade under a certain name in a particular area. If I have a good idea, I can sell you a licence to trade and carry out a business using my idea in your area. The person taking out the franchise puts down a sum of money as capital and is issued with equipment by the franchising company. The firm selling the franchise is called the franchisor and a person paying for the franchise is called the franchisee. Where materials are an important part of the business (e.g. confectionary, pizza bases, hair salons) the franchisee must buy an agreed percentage of supplies from the franchisor, who thus makes a profit on these supplies as well as ensuring the quality of the final product. The franchisor also takes a percentage of the profits of the business, without having to risk capital or become involved in the day-to-day management. The franchisee benefits from trading under a well-known name and enjoys a local monopoly. Training is usually arranged by the franchisor. The franchisee is his or her own boss and takes most of the profits. 10

The following table compares these different types of private sector organizations Every company must register with the Registrar of Companies, and must have an official address. Private companies have Ltd after their name. They are typically smaller than public companies although some like Portakabin and Mars are very large. Shares in a private company can only be bought and sold with permission of the Board of Directors. Shareholders have limited liability. Public companies may have their shares traded on the Stock Exchange. The main advantage of having shares traded on the Stock Exchange is that large amounts of capital can be raised very quickly. One disadvantage is that control of a business can be lost by the original shareholders if large quantities of shares are purchased as part of a takeover bid. In order to create a public company the directors must apply to the Stock Exchange Council, which will 11

carefully check the accounts. Hence, typical samples of the different types of business organization outlined above are: i) Sole traders - like small corner stores and newsagents. If you call out a plumber or electrician they have a good chance of being a sole trader. Although they may also be part of a franchise arrangement or a partnership. ii) Partnership - your doctor or dentist may well be in partnership, as well as solicitors that help your family to buy a house or to make out a will. iii) Private companies - are typically small family businesses that want to keep the control of the business within the family. iv) Public companies - are the well known national and international companies like Vodafone and Corus. v) Franchises - are commonly found in Quick Service Restaurants such as McDonald's as well as in other food outlets, and services such as 24 hour plumbing. Limited liability - is a form of business protection for company shareholders and some limited partners. For these individuals the maximum sum they can lose from a business venture, into which they have contributed going bust, is the sum of money that they have invested in the company - this is the limit of their liability. Financial institutions are those organizations, which are involved in providing various types of financial services to their customers. The financial institutions are controlled and supervised by the rules and regulations delineated by government authorities. Some of the financial institutions also function as mediators in share markets and debt security markets. There the principal function of financial institutions is to collect funds from the investors and direct the funds to various financial services providers in search for those funds. 12

These are the various forms Financial Institutions: Banks Stock Brokerage Firms Non Banking Financial Institutions Building Societies Asset Management Firms Credit Unions Insurance Companies Financial institutions deal with various financial activities associated with bonds, debentures, stocks, loans, risk diversification, insurance, hedging, retirement planning, investment, portfolio management, and many other types of related functions. With the help of their functions, the financial institutions transfer money or funds to various tiers of economy and thus play a significant role in acting upon the domestic and the international economic scenario. For carrying out their business operations, financial institutions implement different types of economic models. They assist their clients and investors to maximize their profits by rendering appropriate guidance. Financial institutions also impart a wide range of educational programs to educate the investors on the fundamentals of investment and also regarding the valuation of stock, bonds, assets, foreign exchanges, and commodities. Financial institutions can be either private or public in nature. The most common forms of financial institutions can be categorized into the following types: Business finance company Mortgage finance company Car finance company Personal finance company Personal loan finance company Home finance company Corporate finance company 13

Thus, it can be concluded that a financial institution is that type of an institution, which performs the collection of funds from private investors and public investors and utilizes those funds in financial assets. The functions of financial institutions are not limited to a particular country, instead they have also become popular in abroad due to the growing impact of globalization Banking Industry Regulation The necessity for public intervention in the economy has traditionally been justified by the need to correct market imperfections and unfair distribution of resources. Hence, the main objectives of such intervention: pursuit of stability, equity of resource allocation and efficient use of resources. From this perspective, financial regulatory mechanisms and regulation of the banking industry in particular can be considered extremely important. Capital accumulation and allocation of financial resources are crucial to economic development of each country. Regulation and supervision of the business activities, pertaining to the banking industry units will be essential for their effective functioning. Generally, the concept of banking regulation and supervision is defined as control over the creation, operation, and liquidation of banks. The most general definition of the concept of banking regulation and supervision is control over the creation, operation, and liquidation of banks. Such control is very diverse, carried out by specialized banking supervisory authorities. Supervision over the bank s operational activities aims to protect the interests of depositors and to ensure effective functioning of the banking industry units. This supervision is the most important and essential part of the functions of banking supervisory authorities, which is carried out in the name of a sound banking system. Supervision is performed continuously throughout the whole operating process of the bank. Although banking regulation and supervision is generally focused on the financial state and business performance of individual banks, its main purpose is to maintain stability of the banking industry. To achieve this goal, banking supervision takes precautions for preventing loss to depositors, and thereby helping to sustain public confidence in banks and the banking industry as a whole. The role of banking regulation and supervision is to create an 14

environment, which supports only reliable and prudent banks and reduces excessive risktaking. Furthermore, banking supervision is required in order to monitor and assist in the early detection of problems in the banking institutions, taking all necessary measures, such as liquidation, with the aim of overcoming and limiting the adverse effects within the affected bank. The banking industry plays a very important role in the development of national economies. Moreover, since borders between the economies of separate countries are progressively losing importance, banks are gradually being incorporated into the global economy. Their role and importance is steadily increasing and today, they represent major players on the market both at domestic and international level. Banking supervision in different countries is characterized by a high degree of uniqueness, resulting from the specificities of the relevant national economy and banking industry. However, supervisory authorities in each country tend to have common goals, related to ensuring the availability of reliable and well-managed banks which do not jeopardize the interests of depositors. Banking supervision should be seen as a dynamic function, responding to market changes. Therefore, national supervisory authorities and international departments should periodically adapt their policies and practices to the changes in economic environment. The legal framework in each country, concerning the banking system, should be flexible enough to allow national supervisors to make those changes. The effective operation of future authority for banking supervision depends on: institutionalization of banking supervision; defining its rights and obligations; creating links with other participants in the banking and insurance network; the presence of laws regulating the creation, ownership, rights, and responsibilities of business organizations, property laws, insolvency and bankruptcy law; the application of the accounting world standards, practices and systems; the presence of an independent external audit and public disclosure of financial audits. All these conditions create a healthy business environment which reduces the risk in the banking industry. 15

Central Banks A Central Bank is a financial institution that controls country s monetary policy, and usually has several mandates including, but not limited to issuing national currency, maintaining the value of the currency, ensuring financial system stability, controlling credit supply, serving as a last-resort lender to other banks and acting as government s banker. The central bank might be or might not be independent the government. In theory independent central bank, will ensure there is no political influence over the central banks policy; however even with the socalled "independent central banks" that is not always the case. Some of the well-known central banks are the US Federal Reserve, Bank of England, Bank of Canada, Reserve Bank of Australia, and the European Central Bank. Some central banks are responsible for single s country monetary policy, for example the Bank of Canada, while others manage the monetary policy of group of countries like the European Central Bank. There is no single naming convention for central bank s naming, but usually the name is in one or close to one of the following forms Bank of [Country], Central Bank of [Country] or National Bank of [Country]. One notable exception here is the US Federal Reserve. On the surface it appears that central banks have noble goals and work for the greater good, however many people consider the real role of a central banking system to be supporting the fractional-reserve banking system, which enriches the financial elite at the expense of the common people. Monetary Policy Central banks manage their countries monetary policies, which includes currency issuing (most world currencies are fiat currencies not backed by silver or gold), maintaining the country s FOREX and gold reserves, managing money supply, and managing the cost of credit by setting interest rates. The monetary policy enforced by a central bank is used in general to influence the economic activity (avoid recessions, facilitate economy growth, etc.) and control inflation. The following are possible policies: 1. Short-term Interest Rates One of the most powerful weapons in central banks arsenal is the short-term interest rate setting. The short-term interest rate is the overnight interbank lending rate. Lowering the 16

short-term interest rate in effect lowers the cost of credit, thus stimulating people and businesses to borrow in hope to expand the economy. Increasing interest rates, makes borrowing more expensive, and is usually used to control overheating economies and inflation. 2. Open Market Operations Open market operations are purchases and/or sales of government securities in the open market. Central banks use open market operations to effectively control the money supply the total amount of money circulating in the country s economy. Purchasing government securities expands the money supply, while selling them actually contracts the money supply. 3. Stock Exchange A stock exchange is an entity which provides "trading" facilities for stock brokers and traders, to trade stocks and other securities. Stock exchanges also provide facilities for the issue and redemption of securities as well as other financial instruments and capital events including the payment of income and dividends. The securities traded on a stock exchange include shares issued by companies, unit trusts, derivatives, pooled investment products and bonds. 1. Dividend A distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders. The dividend is most often quoted in terms of the dollar amount each share receives (dividends per share). It can also be quoted in terms of a percent of the current market price, referred to as dividend yield. 2. Securities A security is a fungible, negotiable instrument representing financial value. Cash is an example of a fungible asset. The exact currency notes received need not be segregated and returned to the owner. A country's regulatory structure determines what qualifies as a security. Securities may be represented by a certificate or, more typically, "non-certificated", that is in electronic or "book entry" only form. Certificates may be bearer, meaning they entitle the holder to rights under the security merely by holding the security, or registered, meaning they entitle the holder to rights only if he or she appears on a security register maintained by the issuer or an intermediary. 17

3. Stock The stock or capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors. Stock is distinct from the property and the assets of a business which may fluctuate in quantity and value. The stock of a business is divided into shares, the total of which must be stated at the time of business formation. Given the total amount of money invested in the business, a share has a certain declared face value, commonly known as the par value of a share. The par value is the de minimis (minimum) amount of money that a business may issue and sell shares for in many jurisdictions and it is the value represented as capital in the accounting of the business If a company has 1000 shares of stock and a person owns 50 of them, then he/she owns 5% of the company. Most stock also provides voting rights, which give shareholders a proportional vote in certain corporate decisions. Only a corporation has stock; other types of companies such as sole proprietorships and limited partnerships do not issue stock. To be able to trade a security on a certain stock exchange, it has to be listed there. Usually there is a central location at least for recordkeeping, but trade is less and less linked to such a physical place, as modern markets are electronic networks, which gives them advantages of speed and cost of transactions. The initial offering of stocks and bonds to investors is by definition done in the primary market and subsequent trading is done in the secondary market. A stock exchange is often the most important component of a stock market. Supply and demand in stock markets are driven by various factors which, as in all free markets, affect the price of stocks (see stock valuation). 18