Chapter 3: Business Environment

Class 12 Business Studies — Detailed Notes

Introduction
Every business operates within a broader environment consisting of various forces
which affect its functioning. Managers need to constantly scan the environment and try
to interpret the effects of the changes taking place, and formulate suitable strategies to
survive and grow.

Meaning of Business Environment

• Business environment is the sum total of all individuals, institutions and other forces
that are outside the control of a business enterprise but that may affect its
performance.
• It comprises everything which is external to the business firm, including customers,
competitors, suppliers, government, and social, political and technological factors.

Features of Business Environment

• Totality of external forces: It is the sum total of all factors which lie outside the
control of individual business enterprises.
• Specific and general forces: Includes specific forces (investors, customers,
competitors, suppliers directly affecting individual enterprises) and general forces
(social, political, legal, technological affecting all enterprises).
• Inter-relatedness: Different elements of business environment are closely
interrelated — e.g. change in import/export policy affects the availability of raw
materials.
• Dynamic nature: Business environment keeps on changing, whether in terms of
technology, customer preference or government policies.
• Uncertainty: It is very difficult to accurately predict future happenings, especially
where technological changes are taking place at a fast pace.
• Complexity: Since it consists of numerous interrelated dynamic factors, it becomes
rather difficult to comprehend at once — the impact of individual factors may not
always be clear.
• Relativity: Business environment is a relative concept, differing from country to
country and even region to region.

Importance of Business Environment

• It enables the firm to identify opportunities and get the first mover advantage:
Timely identification of opportunities helps a firm to be the first to exploit them,
rather than losing them to competitors.
• It helps the firm identify threats and early warning signals: Environmental
awareness can help managers identify various threats on time and serves as an
early warning signal.
• It helps in tapping useful resources: Environment is a source of various
resources (inputs) needed by a firm to produce goods/services.
• It helps in assisting in planning and policy formulation: Environmental
understanding may serve as the starting point for the process of strategy
formulation.
• It helps in improving performance: Firms that continuously monitor their
environment and adopt suitable business practices are more successful.
• Coping with rapid changes: Modern business is characterised by rapidly changing
dynamics, requiring firms to be equipped to face these challenges successfully.

Dimensions of Business Environment

• Economic Environment: Includes factors like interest rates, inflation rates, foreign
exchange rates, money supply, stage of the business cycle, per capita income, and
government's economic/monetary/fiscal policies.
• Social Environment: Includes the customs, traditions, values, beliefs, and general
behaviour and expectations of the society in which the business operates —
influences the demand for goods/services.
• Technological Environment: Includes forces relating to scientific improvements
and innovations that provide new ways of producing goods/services and new
methods and techniques of operating a business.
• Political Environment: Includes factors related to management of public affairs
and their impact on business — political stability, image of the government, ideology
of ruling party.
• Legal Environment: Includes various legislations passed by the government,
administrative orders, court judgements, and decisions of various
commissions/agencies at every level.

Economic Environment in India

• Economic environment includes factors such as national income, GDP growth rate,
distribution of income and wealth, availability of finance, price levels, savings rate
and stock market performance.
• It significantly affects businesses in terms of demand for goods and services,
availability of resources (labour, capital), and government policy relating to taxation,
credit control, industrial licensing and foreign trade.

Impact of Government Policy Changes on Business and Industry

(1991 Economic Reforms)
• In July 1991, the Government of India announced New Industrial Policy involving
liberalisation, privatisation and globalisation (LPG), owing to a severe balance of
payments crisis.

Liberalisation
• Refers to the end of licence-permit-quota raj, i.e. removal of restrictions/controls set by
the government.
• Measures: abolishing industrial licensing for most industries (except a few strategic
industries), freedom in deciding the scale of business activities, reduction in tax rates,
simplified procedures for import/export, easier access to foreign technology and
investment.

Privatisation
• Refers to giving greater role to the private sector and reducing the role of the public
sector.
• Measures: disinvestment of public sector undertakings (sale of equity to private
sector/public), reduction in the number of industries reserved exclusively for the public
sector, deciding a minimum limit for investment by government in select PSUs.

Globalisation
• Refers to the integration of various economies of the world leading to the emergence of
a unified world market.
• Involves free flow of goods, services, capital, technology and even people across
national boundaries.

Effects/Impact of Government Policy Changes (LPG) on Business

and Industry
• Increasing competition: Indian firms had to face competition from domestic firms
as well as global multinational companies.
• More demanding customers: Customers today have become more knowledgeable
and expect superior quality goods/services at reasonable prices.
• Rapidly changing technological environment: Increased competition forces firms
to continuously upgrade their technology/capabilities to survive and grow.
• Necessity for change: Prior to 1991, firms could operate with the same set of
products; now firms have to continuously modify their operations as per changes in
the environment.
• Need for developing human resources: The changing scenario has increased the
need for people with skills like adaptability and a broader knowledge of
developments taking place around them.
• Market orientation: Firms had to shift from selling whatever was produced to
studying customers' needs first and then producing accordingly.
• Loss of budgetary support to the public sector: Public sector had to compete
with the private sector without any special support or protection from the
government.

Business Environment vs Internal Environment

• Internal environment refers to factors within the direct control of the organisation,
such as value system, organisation structure, corporate culture and physical
resources.
• Business (external) environment, on the other hand, consists of factors outside the
organisation's control, and further divides into micro environment (suppliers,
customers, competitors, public — factors specific to a firm) and macro environment
(economic, social, political, legal, technological — factors affecting all firms in the
economy).
• While a firm can adapt or modify its internal environment relatively easily, it has very
little or no control over the external business environment and must adjust its own
strategies to align with it.

Key Terms at a Glance

• Liberalisation: Removal of government controls and restrictions on business (end
of licence-permit-quota raj).
• Privatisation: Giving a greater role to the private sector and reducing the role of the
public sector.
• Globalisation: Integration of various economies of the world leading to a unified
world market.
• Disinvestment: Sale of government equity/shares in public sector undertakings.
• Economic Environment: Interest rates, inflation, income levels and government's
economic policies.

Important Exam Questions

• Define business environment. Explain its features.
• Explain the importance of business environment for a firm.
• Discuss the different dimensions of business environment with examples.
• What is meant by liberalisation, privatisation and globalisation?
• Explain the impact of government policy changes on business and industry after
1991.
• How has the economic environment in India affected businesses in recent years?
• Distinguish between the specific and general forces of business environment.