4 International Business Environment: External Environment -1
Shafali Nagpal
Learning Outcome:
After completing this module the students will be able to:
- To understand various components of external business environment faced by global companies.
- To know about geographic, demographic, economic components of the environment.
Introduction
In addition to the internal environment, which influences a firm’s operations and performance, there are external factors as well, which influence the firms. The external environmental components have a remote, but strong influence upon a firm. Being external, these factors are not within the direct control of a firm and are also called as ‘uncontrollable’ factors. Some of the components of the external environment are:
a) Geographic environment
b) Demographic environment
c) Economic environment
d) Cultural environment
e) Political environment
f) Legal and regulatory environment
The following discussion explains the first three external environmental components – geographic, demographic and economic. The next three environmental components are explained in the next module.
A. Geographic Environment
The geographical environment comprises of various geographical factors that surrounds a firm. The business firms operate in one or more geographical areas and the geographical characteristics of that place assert a direct influence on the firm. The geographical factors comprise of the physical features of the terrain and the climate, which have a lot of influence upon other environmental aspects. The geographical areas vary in terms of the physical features. Some areas are plains, while others are hilly, or deserts. Some areas might be located on river banks, lakes, seas, etc. The soil of some areas might be fertile, while other areas might by rocky and sandy. Some areas might face lot of climatic hazards, for example the hurricanes, earthquakes, extreme weather conditions, heavy rainfall, floods, snowfall, or intense heat. Some areas might have many seasons, while the climate in some areas might be moderate and pleasant. Some of the resulting impacts of these geographic features are:
a) Population density
b) Accessibility
c) Consumption habits
d) Economic development
a) Population density :
The population density depends upon the geographic conditions of a place. People like to live in the areas where the geographic and climatic conditions are favourable. The human population has grown around river beds, coastal areas, fertile plains and valleys. The density of population is very low in the rough terrains, deserts, snow bound areas, areas with dense forests, etc. The business needs people for consumption. Hence, the firms prefer to be located where there is more population as the business operations are far more easy in those areas. We see most of the investment coming in big cities, which are getting bigger because of population migration. Industrial clusters and investments come around the areas with sizable population. The population will determine the size of the market and hence its potential and the firms must choose the countries and the geographical areas, accordingly.
b) Accessibility
The geographic characteristics of an area influence the accessibility and the development of means of transport. In the ancient times, the population grew around the rivers and seas because of the easy transportation. The areas located in rugged terrains would have limited accessibility and the cost of transportation in these areas would be very high. For example, in hilly areas, the cost of transportation of building material is so high that it almost doubles the cost of construction. Similarly, areas with favourable physical features would be easily accessible, often located on well developed roads, rail or waterway transportation facilities. The accessibility also influences the population density and the firms need to take them into consideration as well.
c) Consumption
The consumption patterns of the population are highly influenced by the areas in which they live. The prevailing climatic conditions will decide the type of houses in which they will live in. The building material, the design and the type of houses will vary. Most plains would have flat roofed houses, multiple or group houses and very dense population would be living in small areas. In the hilly areas, the houses would be made of wood and they would be located in far off areas. Similarly, the requirements of energy for heating, or air conditioning of the houses would influence the cost of living.
The people’s clothes would depend upon the area in which they are living. The people living in hot areas would prefer light clothing, while those living in the cold areas would prefer the woollen clothing, which could be costlier. The firms will have to design their garments depending upon the markets in which they are selling the products. The areas with more seasons would create more demand for a wide range of products, while the areas with more or less similar climatic conditions would create lesser needs as the clothes and other requirements would not need much replacement.
Peoples’ food is highly dependent upon the geographical area in which they live. The people living in the areas with fertile soil would prefer grains, vegetables, dairy products, etc. The people living in cold countries would be non-vegetarian and those living in hot and humid areas would prefer lighter food. Geographical areas have another sociological aspect, where the people of similar beliefs, language and culture would live together, and the consumption would also be influenced accordingly.
d) Economic development
There is an indirect association between the geographical area and its economic development. But, the population leads to business, more investment, more employment, and hence more economic development. World-over, the economic development has happened in clusters, often in favourable physical conditions as well. The fertile plains of Ganga, the coasts, the plains of Deccan have attracted investment and have much better infrastructure as compared on far flung areas. Peoples’ consumption changes significantly with the area’s economic development. The requirements of cars, houses, material pleasures, etc. is highly influenced by the economic development of that area.
The above discussion shows that the geographic features of an area have a lot of influence on a firm and they must consider these aspects while deciding upon the location of a firm, and then the strategies and plans to run the business operations.
B. Demographic environment
Demographic environment of a country refers to the pattern of population and the changes in the societies, cities, regions and nations. It analyses the population characteristics on the basis of age, gender, education, marital status, household patterns, religion, nationality, ethnicity, etc. Demography provided an analysis of qualitative as well as quantitative aspects of the population. Some of the issues covered under demographic environment are:
a) Population size:
The very size of a population determines the size of the possible business. It represents the potential to which the market can expand. By virtue of their population, China and India are considered to be very powerful emerging economies, overtaking even the developed nations. All the multinational companies are making their way into these markets have tremendous potential for consumption.
b) Age distribution
In India, we are witnessing an increase in the population in the age group of 15-40 years, i.e., the productive people. This means that the economic prosperity of people is likely to increase in the times to come. India is called Youngistan because the young population represents hopes and aspirations and also the capacity and energy to realize those dreams, and hence offers opportunities to the business firms.
On the other hand, we find an increasing population of old people in countries like Japan. This is because of very low birth rates and high life expectancy. This can influence the spending habits and business potential significantly.
c) Migration
The migration of people from villages to cities, and from the country to other countries in search of job has a high influence on the business potential. People increase their economic prosperity by movement and thus the business potential grows. There is an increasing trend amongst the people to move towards metropolitan cities, where there are more jobs, better living standards and a different lifestyle.
d) Education and occupation
There is a trend towards higher education and preference for white collar jobs over the blue collar jobs. This also has a tremendous impact on the spending habits of the business.
e) Family size and structure
The size of family and its structure has a significant impact on the consumption patterns. In the rural and semi-urban areas, still joint families exist. The members of the family have an important say in the matters concerning other members. In the cities, there is increasing trend towards nuclear families and their lifestyle and consumption is undergoing a major change.
Demographic characteristics of population must be studied by the firms before they decide to venture into any overseas market. In a fast changing society, the nature of demographic indicators of the population is undergoing a change and each change represents an opportunity to the business firms. The growth of several emerging economies like China, India, Brazil, South Africa, etc. is largely due to the robust demographic profile of these societies.
C. Economic environment
The economic environment is a major determinant of market potential and opportunity. Since the single most important indicator of market potential is income, the first step in determining the potential of a country or a region is to identify the total, and even more significantly, the per capita income. In general, as peoples’ income rises, they spend less on the necessities and more on the discretionary purchases. One of the ways of determining market potential for a product is to evaluate product saturation levels. In general, it is appropriate to compare the saturation levels of countries or of consumer segments with similar income levels. Countries and markets go through typical stages of market development. Although, development is on a continuum, it is possible to identify distinct stages and formulate general estimates about the type of the market that will be found in a country or a market at a particular stage of development. In advanced countries, for example, more than half the GNP is accounted for by the services as opposed to goods. In under-developed countries, the proportion of services is very low.
Changes in world economy
Over the years, several changes have taken place in the world economy, which have changed the very manner of doing business. Keegan has identified the five most significant changes in the world economy, which have occurred in the past decades, and will influence the conduct of business. These changes are:
a) Increasing capital movement.
In the present time, capital movement rather than trade have become the driving forces of world economy. The capital movement represents the attractiveness of a country for investment. For example, by its favourable pro-business policies, China has attracted the maximum investment. In no time, China is likely to emerge as the manufacturing base for the whole world. Many countries were ahead of China in terms of trade, but they feel the threat to their economy because of a sudden increase in the economic potential of China, arising because of huge foreign investment.
b) Jobless growth
Despite economic development, the production has become uncoupled from employment and the Government of India claimed to have touched 8% growth in the GDP, the growth is a jobless growth. The increase in productivity does not translate into more jobs for the people. Such a situation is not good for the economies in the long run because a large section of the society will be siphoned out of the economic activities.
c) Value driven competition
The primary products have become uncoupled from the industrial economy and in the industrial economy, focus is more on innovation and value addition and not mere value addition. Michael Porter has stated in his book, “The Competitive Advantage of Nations,” that as an economy progresses, it is driven by the factors of production, namely land, labour, capital and management. However, after one stage, it stops getting leverage out of mere factors of production. It becomes a wealth driven economy. Here, wealth begets more wealth.
However, in long run, such a strategy is not going to deliver results. If an economy aspires to grow further, it has to become an innovation driven economy. Thus, primary products cease to the driving forces of the industry. Industry is going in for rapid innovation and thus is aiming at delivering higher value to its customers.
d) Globalization
The global forces of the world economy are in control and the macro economics of nation-states no longer control economic outcomes. Keegan observes a gradual separation between economics and politics, although the shift is very subtle. The economy is in the control of the market forces because more and more governments are opening up and allowing business to work freely.
e) Free market economy
The free market economy, where market forces control the economy, the state intervention has been reduced. The 75-year contest between capitalism and socialism is over. The clear success of the capitalist system over the communist centrally controlled model has led to the collapse of communism as a model of organization of economic activity and as an ideology.
By the above remarks, it is clear that the world economy is heading for a new world economic order. The leftist forces are not as strong as they were on the yesteryears. The world is no longer a bi-polar world, but is now a multi-polar world with many regional economic groupings and powers. The democracy has shown a definite edge over other systems and is likely to persuade more and more countries to allow free play of the market forces.
Elements of Economic Environment
Economic environment is a multidimensional entity and it has dynamic interaction with other environmental components as well. While there are many elements of the economic environment, it comprises of five main components, as mentioned below:
a) Economic Conditions
b) Economic System
c) Economic Policies
d) International Economic Environment
e) Economic Legislations
These components are explained in the following discussion.
a) Economic Conditions
In order to understand the economic condition, it is pertinent to have a look at the state of economy of India since last decade. From the stage of ‘India Shining’ in 2004, when all the economic indicators showed a robust economic health of the nation, today we are facing tough times. The inflation and interest rates are very high, whereas the economic growth, budgetary deficit, value of rupee is touching the lowest benchmarks. Deteriorating economic conditions have eroded the investment, leading higher unemployment and the country is passing through a tough time. Economic Policies of a business unit are largely affected by the economic conditions of an economy. Any improvement in the economic conditions such as standard of living, purchasing power of public, demand and supply, distribution of income etc. largely affects the size of the market.
The economic condition passes through the business cycles, which has five stages – Prosperity, Boom, Decline, Depression, and Recovery. The prudence of the economists lies in how they are able to prolong the prosperity and boom, and reduce the impact and duration of decline and depression. As explained earlier, Indian economic is definitely passing through a phase of slowdown and the skill of the economists managing the affairs lies in how they are able to get to the recovery stage.
In order to assess the economic condition of a country, it is important to study the following economic conditions:
(i) Stages of Business Cycle
(ii) National Income, Per Capita Income and Distribution of Income
(iii) Rate of Capital Formation
(iv) Demand and Supply Trends
(v) Inflation Rate in the Economy
(vi) Industrial Growth Rate, Exports Growth Rate
(vii) Interest Rate prevailing in the Economy
(viii) Trends in Industrial Sickness
(ix) Efficiency of Public and Private Sectors
(x) Growth of Primary and Secondary Capital Markets
(xi) Size of Market
b) Economic Systems
An Economic System of a nation or a country may be defined as a framework of rules, goals and incentives that controls economic relations among people in a society. It also helps in providing framework for answering the basic economic questions. Different countries of a world have different economic systems and the prevailing economic system in a country affect the business units to a large extent. Economic conditions of a nation can be of any one of the following type:-
(i) Capitalism
The economic system in which business units or factors of production are privately owned and governed is called Capitalism. The profit earning is the sole aim of the business units. Government of that country does not interfere in the economic activities of the country. It is also known as free market economy. All the decisions relating to the economic activities are privately taken. Examples of Capitalistic Economy:- England, Japan, America etc.
(ii) Socialism
Under socialism economic system, all the economic activities of the country are controlled and regulated by the Government in the interest of the public. The first country to adopt this concept was Soviet Russia. The two main forms of Socialism are: –
i. Democratic Socialism:- All the economic activities are controlled and regulated by the government but the people have the freedom of choice of occupation and consumption.
ii. Totalitarian Socialism:- This form is also known as Communism. Under this, people are obliged to work under the directions of Government.
iii. Mixed Economy:- The economic system in which both public and private sectors co-exist is known as Mixed Economy. Some factors of production are privately owned and some are owned by Government. There exists freedom of choice of occupation and consumption. Both private and public sectors play key roles in the development of the country.
At the time of independence, India had opted for a socialist economy, which has transformed into the market led economy. Although we have a free market economy, the government and the government owned institutions play an important role in the economy. Hence, we are a mixed economy even in the present times.
c) Economic Policies
Government frames economic policies. Economic Policies affects the different business units in different ways. It may or may not have favorable effect on a business unit. The Government may grant subsidies to one business or decrease the rates of excise or custom duty or the government may increase the rates of custom duty and excise duty, tax rates for another business. All the business enterprises frame their policies keeping in view the prevailing economic policies. Important economic policies of a country are as follows:-
(i) Monetary Policy
The policy formulated by the central bank of a country to control the supply and the cost of money (rate of interest), in order to attain some specified objectives is known as Monetary Policy.
(ii) Fiscal Policy
It may be termed as budgetary policy. It is related with the income and expenditure of a country. Fiscal Policy works as an instrument in economic and social growth of a country. It is framed by the government of a country and it deals with taxation, government expenditure, borrowings, deficit financing and management of public debts in an economy.
(iii) Foreign Trade Policy
It also affects the different business units differently. E.g. if restrictive import policy has been adopted by the government then it will prevent the domestic business units from foreign competition and if the liberal import policy has been adopted by the government then it will affect the domestic products in other way.
(iv) Foreign Investment Policy
The policy related to the investment by the foreigners in a country is known as Foreign Investment Policy. If the government has adopted liberal investment policy then it will lead to more inflow of foreign capital in the country which ultimately results in more industrialization and growth in the country.
(v) Industrial Policy
Industrial policy of a country promotes and regulates the industrialization in the country. It is framed by government. The government from time to time issues principals and guidelines under the industrial policy of the country.
d) Global/International Economic Environment
The role of international economic environment is increasing day by day. If any business enterprise is involved in foreign trade, then it is influenced by not only its own country economic environment but also the economic environment of the country from/to which it is importing or exporting goods. There are various rules and guidelines for these trades which are issued by many organizations like World Bank, WTO, United Nations etc. Besides the above policies, Governments of different countries frame various legislations which regulates and control the business.
Summary
The external environment is not a monolithic entity, but comprises of many components. The physical features of an area have an important influence on the settlement of populations and hence on the investment decisions of the firms. Business prefers to grow around places with good accessibility, moderate climate and sizable population. In addition to the numbers, the nature of human population also has lot of influence on the businesses. The demographic characteristics, such as the age profile of the population, the gender ratio, income, literacy, population growth, health, etc. have a lot of influence on the consumption. The emerging economies like India, China, Brazil, South Africa, etc. have a large proportion of young population, triggering economic growth. The economic environment comprises of several components, such as the economic conditions, economic system, economic policies, international economic environment, and the economic legislations. India has recently started experiencing the economic slowdown, although it had remained aloof from the global economic slowdown for long. Various economic policies – monetary, fiscal, foreign trade, foreign investment, and industrial policies have a lot of influence on the economic environment of the countries. The firms need to carefully monitor these components before taking the investment decisions.
Suggested Readings Books
- Cateora Philip R (1997), International Marketing, 9th Edition, Irwin/McGraw HIU,
- Terpestra, Vern (1972) International Marketing, Halt, Reinhart and Winsten Inc.
- Sundaram, Anant K. and J. Stewart Black (2000) The International Business Environment: Text and Case s, Prentice Hall of India Pvt. Ltd., New Delhi.
- Keegan, Warren J. (1997) Global Marketing Mangement, Prentice Hall of India Pvt. Ltd., New Delhi.
- Cherunilam Francis (2004) International Business: Text and Cases, Prentice Hall of India Pvt. Ltd., New Delhi