Analysing the external environment to assess opportunities and threats: economic change

Welcome to the World Outside: Analysing Economic Change

Hello there! Today, we are going to look at the External Environment. Imagine a business is like a ship at sea. The manager is the captain, but they can’t control the weather or the waves. In business, "the weather" is the external environment. Specifically, we are looking at Economic Change.

By the end of these notes, you’ll understand how things like interest rates, incomes, and government rules can either be a "sunny day" (an opportunity) or a "storm" (a threat) for a business. Don't worry if this seems a bit big—we’ll break it down piece by piece!

1. What is the External Environment?

The external environment consists of all the factors outside of a business that can affect its success. Since the business cannot control these things, it must monitor them and adapt its strategy.

Quick Review:
• Opportunities: External factors that could help a business grow or make more profit.
• Threats: External factors that could harm a business or reduce its profits.

Memory Tip: Think of PESTLE. While we are focusing on the E (Economic) today, remember that businesses are always watching for Political, Economic, Social, Technological, Legal, and Environmental changes!

2. Changes in Incomes

Income is the money people earn from work or investments. When the economy is doing well, incomes usually rise. When it’s struggling (a recession), incomes might fall.

How it affects businesses:

• Luxury Goods: If incomes rise, people buy more "treats" like designer clothes or expensive holidays. These businesses see an increase in demand.
• Necessities: If incomes fall, people still need bread and milk. However, they might switch from "premium" brands to "budget" supermarket brands.
• The Formula: \( \text{Profit} = \text{Total Revenue} - \text{Total Costs} \). If incomes rise and demand goes up, Revenue increases, which usually leads to higher Profit!

Real-World Example: If a local factory closes and many people lose their jobs, the high-end cafe nearby (a luxury) might see fewer customers, while the local discount store might see more.

Key Takeaway: Rising incomes are usually an opportunity for most businesses, but falling incomes can be a threat—unless you sell very cheap, essential products!

3. Interest Rates

Think of an interest rate as the "cost of borrowing money" or the "reward for saving money."

If Interest Rates RISE:

• Costs go up: If a business has a loan, they have to pay more back to the bank. This increases their costs.
• Demand goes down: Consumers have less money to spend because their mortgages or car loans become more expensive. Also, they might choose to save money rather than spend it to get that high reward from the bank.

If Interest Rates FALL:

• Investment increases: It is cheaper for a business to borrow money to buy new machinery or open a new shop.
• Spending increases: Consumers feel "richer" because their loan payments are lower, so they spend more.

Common Mistake to Avoid: Many students forget that interest rates affect both the business costs AND the customers' willingness to spend. Always mention both in your exam answers!

Key Takeaway: High interest rates are usually a threat (higher costs, lower sales), while low interest rates are an opportunity (cheaper to grow, higher sales).

4. Exchange Rates

An exchange rate is the price of one currency in terms of another (e.g., how many Dollars you get for one Pound). This is very important for businesses that trade abroad.

Memory Aid: SPICED
Strong
Pound (or your local currency)
Imports
Cheap
Exports
Dear (Expensive)

How it works:

• If your currency is STRONG: It’s an opportunity for businesses that buy raw materials from abroad because those "imports" are now cheaper. However, it’s a threat for businesses that sell to other countries because their products look more expensive to foreign customers.
• If your currency is WEAK: It’s the opposite! Exports are cheaper (opportunity to sell more abroad), but importing materials becomes more expensive (threat to profit margins).

Key Takeaway: Whether a change in exchange rates is good or bad depends entirely on whether the business imports or exports.

5. Costs of Inputs

Inputs are the things a business needs to make its product, like raw materials (flour for a baker), energy (electricity), and labor (wages for workers).

• The Threat: If the price of oil goes up, delivery costs for every business go up. If a business cannot raise its own prices, its profit margin will shrink.
• The Opportunity: If a new technology makes raw materials cheaper to produce, a business can lower its costs and become more competitive.

Analogy: If the price of lemons doubles, your lemonade stand has to either charge customers more or make less profit on every cup sold.

Key Takeaway: Changes in input costs directly affect the efficiency and profitability of a business.

6. Government Policies

Governments can change the "rules of the game" at any time. Two main ways they do this are through taxation and spending.

• Taxes: If the government increases Income Tax, people have less money in their pockets to spend (Demand falls). If they increase Corporation Tax, the business keeps less of its profit.
• Spending: If the government spends money on new schools or roads, it creates jobs and gives businesses (like construction firms) more work.
• Regulation: New laws (like a higher minimum wage) can increase a business's costs but might improve the lives of workers.

Key Takeaway: Government policy can be a tool to help the economy grow (opportunity) or a way to collect more money, which might increase business costs (threat).

7. Competition (Domestic and Abroad)

Competition is about how many other businesses are trying to sell to the same customers.

• New Entrants: If it’s easy for new businesses to start (low barriers to entry), competition will be high. This is a threat as it may force a business to lower its prices.
• International Competition: Because of the internet and better shipping, a small business in your town might be competing with a giant company from the other side of the world!
• The Upside: Competition can be an opportunity if it forces a business to become more efficient or innovative to stay ahead.

Quick Review Box:
High Competition = Need for lower prices or better marketing.
Low Competition = Business can potentially charge higher prices and make more profit.

Summary Checklist: Are you exam-ready?

Before you finish, make sure you can explain how a business might react to:
1. A sudden increase in interest rates. (Hint: Think about loan costs and customer spending).
2. A fall in the value of the national currency. (Hint: Use SPICED).
3. A government decision to lower income tax. (Hint: More money for customers!).
4. A rise in the cost of raw materials. (Hint: Impact on profit margins).

Don't worry if this feels like a lot to remember. Just keep thinking: "If this happens in the world, does it make the business's life easier (Opportunity) or harder (Threat)?" If you can answer that, you're doing great!