The Concept of a Business Environment
A business environment refers to all conditions, whether internal or external, that affect the operations or success of an institution established with an aim to make profits.
There are three distinct business environments which are:
- Internal business environment
- External business environment
- Operating business environment
Internal business environment
This type of business environment is within the organization and the organization has control over it. Its components are mission and vision of the organization, employees, managerial and leadership philosophies, organizational culture, organizational structure and policies of the organization.
External business environment
This type of business environment includes the factors outside a business that influence its decisions. It is also called macro environment. Its components are well captured by the acronym PESTEL which includes political, economical, social, technological, environmental/ecological and legal environments.
Operating business environment
This is environment which affects the operations of an organization and basically constitute of customers, creditors, competitors, marketing intermediaries like middle men and other publics of a firm.
Models of Environmental Analysis
Several models are used to understand the surrounding situation. These models include:
- SWOT analysis
- Porters five forces analysis
- PESTLE Analysis
These are further explained below.
SWOT analysis in the analysis of business environment
SWOT stands for strengths, weaknesses, opportunities and threats. To understand SWOT analysis in the analysis of business environment, the four terms should clearly be distinguished.
- Strengths refer to positive internal conditions in the environment like competent staff, superior technology, strong customer and capital base. A media house may for instance count on its strength as having the largest viewership and listenership in a given region.
- Weaknesses are negative internal conditions in the environment e.g. poor technology, low customer base and poor image.
- Opportunities are positive external conditions in the environment. This is when PESTEL factors are in favor of a firm like favorable legislations, new markets are developing for the firm and increased demand of a firm’s products.
- Threats are negative external conditions in the business environment like stiff competition, unfavorable legislations, and poor economic and political environments among other factors.
A firm can explore the available opportunities in the business environment by use of appropriate strategies supported by its strengths. A firm has an advantage of opportunities but a disadvantage of weaknesses.
An example is a country rich in oil but does not have the technology to exploit it. In such a scenario, the country can use its opportunities to overcome its weaknesses. It can for instance look for a firm with appropriate technology to exploit the oil and then share profits therefrom on a predetermined ratio.
In this scenario, threats like competition affect strengths of a firm. A company which may be enjoying monopoly may for instance have entrants of new competitors which may affect its sales turnover. The firm in this case must identify ways to use its strengths to reduce its vulnerability to external threats like coming up with strategies to manage competition.
An example is a company enjoying economies of scale and strong capital base. It will use funds at its disposal to aggressively advertise and surpass competition.
Performing a SWOT Analysis
- What do you do well?
- What do other people ask you for help on?
- What is unique about you?
- What are your weak areas?
- In what areas do you have fewer resources?
- Do others avoid asking you for help on certain things?
- What trends can you take advantage of now?
- How can you leverage your strengths?
- Are there any opportunities immediately open to you?
- What is your competition doing?
- Do any of your weaknesses pose an immediate threat?
- Is there anything that you must address right now?
Porter’s five forces in the analysis of business environment
Michael Porter developed the five forces model to examine an industry’s attractiveness and analyze business environments. The company must therefore examine several major structural factors that affect long term attractiveness. The five forces model is useful in understanding the industry context in which a firm operates. They are discussed here below:
Rivalry posed by competitors/ threat of new entrants
A market with strong rivalry is less attractive. Firms are always in competition for market share. Firms in overcoming this challenge always seek to diversify their product portfolio to meet varied needs of the customers.
Limited market growth and size causes firms to fight for the available market share. Firms overcome this challenge by venturing into new markets. In this era of globalization, many firms are venturing into international markets.
High fixed and storage costs intensify rivalry since firms seek to make returns on the expenses incurred in addition to profits. To overcome this challenge, firms always seek to lower expenses incurred by cutting on unnecessary costs.
Low switching costs increase rivalry among firms. Switching costs are also called switching barriers and refer to any impediment to a customer’s changing from one product to the other.
Growth strategies that can be solutions to rivalry among firms.
- Market penetration
- Market development
- Product development
1. Market penetration
An organization seeks to have more consumption of its existing products in its existing markets through aggressive adverting and marketing. It is the least risky strategy among the four strategies. The aim is to increase the market share of the existing products.
2. Market development
This involves taking existing products to new markets. This has been the trend in Eastern Africa where many organizations have been extending their operations beyond their countries of operations to the wider region.
3. Product development
This involves developing new products for the existing market. Mobile telephone companies have for instance established money transfer services within their existing markets as a new product.
This involves development of new products to new markets. It is the most risky strategy and its quadrant is referred as “suicide cell”. It is an option when good returns are expected. Among the four strategies, market penetration is least risky but once the market is saturated, other strategies must be sought.
Market penetration is the least risky followed by market development, then product development whereas diversification is the most risky.
This refers to barriers and challenges which prevent new players who want to operate in the market from entry. An industry with entry barriers is less attractive and thus will discourage new entrants. Existing firms may deliberately create entry barriers to reduce entry of new firms so that they can be able to maintain a steady level of profits.
It is expected that when an industry profits increase, additional firms will enter in the market to take advantage of the opportunities. This however does not usually happen because of certain barriers including the existing firms establishing these walls to ensure profits are not driven down by firms at the entry point.
Some of these barriers that prevent entry of new firms include:
- Government regulations
- Brand loyalty
- Economies of scale
- High switching costs to the customer
New firms may face the hurdle of compliance matters with the government regulations and requirements including registration processes which are lengthy, technical and cumbersome. Governments in other industries grant monopolies limiting entry of new firms.
This refers to the loyalty customers may have on the existing brands denying market to new brands at the entry stage.
Economies of scale
Existing players may enjoy economies of scale thus are able to have enough funds to sponsor powerful adverts denying market penetration to players at the entry level.
Lack of capital base
Firms at the entry level usually do not have enough capital to enable them match up with existing firms in terms of human resource, quality and diversification. Existing players have enough funds thus are able to produce highly differentiated products.
High switching costs to the customer
Switching costs refer to the value and benefits a customer would lose by deciding to use another product to meet the same needs he used to meet with a previous product. A good example is mobile telephone industry. A customer may find it difficult to move to another service provider at the entry level even when the prices of such a firm are low.
This is because the inconveniences of changing the telephone number and missing out on other services like money transfer make the switching costs high. This is why entry and penetration of new players in the telephone industry has always been difficult. Patents and proprietary rights thus effectively acts as a barrier to entry. Also, an entrepreneur must assess this when analyzing the business environment.
Threat of substitutes
An industry is less attractive if actual or potential substitutes exist. Substitute products refer to different products having ability of satisfying customer’s needs similarly.
Bargaining power of the buyer
This refers to the ability of the consumer to bargain for either low price or high quality of the product. Organizations should also consider this kind of business environment.
Factors determine the bargaining power of a buyer
- Low switching costs
- Backward integration threats
This is a market in which there are many sellers and one buyer. In such a market, a buyer is a chooser among many suppliers and thus has more bargaining power.
Low switching costs
This is when a customer can easily move to another product which will equally meet his needs (substitute). When a customer can decide to use a substitute without difficulties, he has a higher bargaining power over the supplier who is currently supplying him with products.
Backward integration threats
Backward integration refers to the situation where a company takes over the functions of the supplier. It is one of the forms of the vertical integration. The other form is forward integration where a company takes over the distribution functions. This must be considered since it is a critical component of a business environment.
Backward integration threats increase the bargaining power of the buyer since the supplier will have fears of losing business.
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