Business (9625) | Analysing the external environment to assess opportunities and threats: economic change

Analysing the External Environment: Economic Change (3.3.5)

Hello everyone! Welcome to one of the most vital chapters in business strategy. Strategy isn't just about what happens inside the company; it's about reacting to the world outside. This chapter is all about the 'E' in PESTEL (Economic factors).

We will explore major national and global economic changes—like fluctuating prices, high interest rates, or changes in employment—and see how these movements create major opportunities (chances to make more money or expand) or threats (risks that could harm the business) that require strategic business decisions.

Understanding these forces is essential because you cannot control the economy, but you must adapt your strategy to survive and thrive within it!

1. Core Economic Health Indicators

These factors tell us how wealthy and confident consumers and businesses are feeling, directly impacting demand and strategic planning.

Gross Domestic Product (GDP)

Gross Domestic Product (GDP) is the total value of all goods and services produced in a country over a specific period (usually a year). Think of it as the country’s economic report card.

• GDP Growth (Opportunity): When GDP is rising, the economy is expanding. Consumers have more confidence and higher incomes, meaning they buy more products.
  Strategic Response: Businesses might choose strategies focused on growth, higher investment, or launching new products (Ansoff’s New Product Development/Market Penetration).
• GDP Decline (Threat): When GDP falls (or even enters a recession), consumer spending drops significantly. This means lower demand for most products (especially luxury goods).
  Strategic Response: Businesses must focus on survival, cost minimisation, efficiency, and potentially target cheaper, value-focused products.

Inflation and Deflation

Inflation is the sustained rise in the general price level of goods and services over time, reducing the purchasing power of money.

Deflation is the sustained decrease in the general price level. While this sounds good for consumers, it often signals very weak demand and can lead to lower business profits.

• Impact of Inflation (Threats):

  Rising prices mean the costs of inputs (raw materials, wages, energy) increase. Operations managers struggle with rising unit costs. If the business raises its own prices to compensate, it risks losing demand to cheaper rivals (competitiveness issue).

• Impact of Deflation (Threats/Opportunities):

  Deflation generally means consumers delay purchases, expecting prices to fall further. This is a huge threat to demand. However, it can reduce the price of imported inputs (opportunity).

Unemployment

Unemployment measures the percentage of the workforce actively looking for a job but unable to find one.

• High Unemployment (Opportunity):

  If many people are jobless, it's easier for a business to recruit staff. The labour market is a 'buyer's market', and wage demands may be lower, reducing HR costs (Opportunity for Operations and HR).

• Low Unemployment (Threat):

  If almost everyone has a job, businesses must compete fiercely for skilled workers. Wages are driven up (threat to costs) and staff retention becomes a major focus for HR strategy.

  Did you know? Low unemployment is also a sign of a strong economy, meaning consumer confidence (and thus demand) is high, providing a marketing opportunity!

2. Monetary Policy: Interest Rates and Exchange Rates

These factors are often controlled by central banks and have a massive impact on borrowing, investment, and international trade.

Interest Rates

Interest rates are the cost of borrowing money and the reward for saving it. They directly influence a business’s financial decisions and consumer demand.

• Rising Interest Rates (Major Threat):
  1. Finance/Investment: Borrowing becomes more expensive. Businesses are less likely to fund major strategic projects (like buying new machinery or building new factories). This reduces Return on Investment (ROI).
  2. Consumer Demand: Consumers with mortgages or loans have less disposable income after making repayments, so they cut back on spending (threat to demand).

• Falling Interest Rates (Major Opportunity):

  Borrowing is cheap! Businesses can afford large capital investment projects (Opportunity for growth and competitiveness). Consumers have more money to spend, boosting demand.

  Analogy: Think of interest rates as the "cost of speed." When they are low, businesses hit the gas and invest; when they are high, they slow down and conserve cash.

Exchange Rates and Volatility

The exchange rate is the price of one currency in terms of another. Changes here are crucial for any business that imports inputs or exports finished goods.

Exchange rate volatility refers to how frequently and significantly the rate changes, making future planning (forecasting costs and revenue) very difficult and risky.

Understanding Movement (A Simple Trick):

• If your currency strengthens (it buys more foreign currency):
  For example, the Euro (€) strengthens against the Dollar ($).
  • Importers (Opportunity): It is cheaper to buy foreign raw materials.
  • Exporters (Threat): Your products are now more expensive for foreign buyers, reducing demand.
• If your currency weakens (it buys less foreign currency):
  For example, the Euro (€) weakens against the Dollar ($).
  • Importers (Threat): Foreign raw materials become more expensive (higher input costs).
  • Exporters (Opportunity): Your products are cheaper for foreign buyers, boosting demand.

Key Takeaway: Exchange rate movements directly influence pricing strategy, supplier choices (Operations), and market entry decisions (Marketing/Strategy). High volatility makes risk management a strategic priority.

3. Government Action and Resource Constraints

Taxation

Governments use taxation to raise revenue and influence economic behaviour.

• High Direct Taxes (Income/Profit Tax - Threat): If income tax rises, consumers have less disposable income, decreasing demand. If Corporation Tax (profit tax) rises, profits after tax fall, reducing funds available for strategic reinvestment.
• High Indirect Taxes (e.g., VAT, Sales Tax - Threat): If taxes on purchases rise, products become more expensive for consumers, often reducing demand.
• Grants and Subsidies (Opportunity): Government policy often provides these supports to specific industries (e.g., green energy, technology). This reduces operating costs and encourages investment, potentially driving a strategic shift into these areas.

Free Trade vs. Protectionism

This relates to how easily businesses can trade internationally.

• Free Trade (Opportunity): Low or no barriers (like tariffs or quotas) means businesses can easily access cheaper global supply chains (Operations opportunity) and sell products into huge international markets (Market Development opportunity).
• Protectionism (Threat): When governments impose tariffs (taxes on imports) or quotas (limits on quantities) to protect domestic industries. This increases the cost of imports for the business and reduces access to foreign markets (a major strategic threat for businesses looking to internationalise).

Investment in and Quality of Infrastructure

Infrastructure includes physical assets like roads, ports, broadband, and energy grids.

• Poor Infrastructure (Threat): Bad roads lead to higher logistics costs and delays in supply chains (Operations issue). Slow internet hinders e-commerce and communication.
• Good Infrastructure (Opportunity): Efficient transport and fast digital networks reduce costs, increase speed of response, and improve overall operational efficiency.

Prices of Resources (e.g., Oil)

For many businesses, global resource prices (especially oil and energy) are a crucial input cost.

• If oil prices spike globally, costs rise dramatically across the supply chain—from transporting raw materials to running factory machinery (major threat to costs and profit margins).
  Strategic Response: Businesses might adopt strategies focused on sourcing inputs closer to home or investing heavily in energy-efficient technology.

Labour Markets

Beyond simple unemployment rates, the economic health of the labour market involves the availability of skills and the general wage levels.

• If the economy grows quickly, competition for specialized skills (e.g., coding, engineering) increases, leading to higher wage bills and potential strategic difficulties in maintaining a competitive advantage based on low costs.

4. The Importance of Globalisation for Business Strategy

Globalisation is the increasing interconnectedness of countries through trade, investment, technology, and cultural exchange. It means economic changes in one country can quickly affect others.

Global Economic Trends and Strategy

Changes in the global economic environment force businesses to make decisions about internationalisation (Section 3.3.9.3).

1. Access to Emerging Economies (Opportunity): Developing countries often offer vast new markets for products (Market Development) or cheaper labour and lower operating costs (leading to decisions to off-shore production).
2. Global Competition (Threat): Businesses face increased rivalry from abroad, forcing them to focus constantly on maintaining a competitive advantage through low costs or differentiation.
3. Technological Trends: Global digitalisation has made international trade easier (e-commerce), but also exposes businesses to international cyber threats.
4. Global Supply Chains: Businesses rely on suppliers scattered across the world. Economic instability or protectionist policies in any one country can disrupt the entire supply chain, making it a strategic decision whether to use Just-In-Time (JIT) or Just-In-Case (JIC) inventory control.