Business Environment Analysis: Why It Matters

Before businesses launch a product or enter a target market, they conduct extensive research to determine the success rate of the business venture. They look at the market need for their product, identify their customers and competition, and review the laws and regulations governing the sale or production of their product. The list goes on.

Many factors determine the success or failure of a business, including the environment in which it operates. Identifying the environmental elements that impact a business is key to understanding and adapting to market trends. While we can’t control the ebb and flow of market changes, we can analyze the environment and make better-informed decisions.

Business owners who fail to account for the business environment are liable to make choices that adversely affect business profits and future growth.

According to statistics from the Small Business Administration, around 32% of business startups fail before two years. 51.1%, meanwhile, fail in five years. After ten years, only 33.6% startups survive. Although many factors may have contributed to the business failure, ineffective planning due to a lack of a business environment analysis can be one of them. A good option to conduct a business environment analysis is to refer to a digital marketing agency.

This article will discuss business environment analysis and why it is important.

Let’s first define the business environment.

What is the Business Environment?

A business environment refers to the factors or forces that influence the operations and growth of organizations. These factors could be internal, for example, HR policies and customers’ expectations, or external, for instance, government regulations and technological innovations.

Business environments can be characterized as follows:

1. In interdependent environments, elements are linked so that if one element changes the others are affected.
2. In dynamic environments, one or more elements are constantly changing, for example, consumer behaviors or technological development.
3. In relative environments, the environmental elements differ depending on the location of the business.
4. Uncertain environments are business environments that are hard to predict.
5. In multi-faceted environments, environmental changes are either a threat or opportunity depending on the business. For example, the pandemic lockdowns boosted online businesses but set back restaurants.

Managers can only make strategic decisions when they understand their business environment and how it affects performance and profitability.

4 Types of Business Environments

Having defined and characterized what a business environment is, let’s look at the four types of business environments:

1. Internal Environment

The internal business environment are factors within a company that affect growth and profitability. As something the business can control, it can be changed to produce the desired results. For example, when conducting employee wellness checks, you discover that most of your staff is overwhelmed with project deadlines. You could augment your staff to lighten the workload.

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Internal factors that influence the business environment include company culture, organizational structure, physical resources, and HR policies and processes.

First, work culture has a profound effect on the functioning of a company. It shapes employees’ attitudes, values, and interactions with each other, third parties, and customers. The type of culture you create affects profitability. According to Forbes, companies with strong cultures have four times revenue growth.

Second, the way your company is structured determines decision-making. With a hierarchically structured organization, decisions come from the top down. With horizontally structured organizations, relevant stakeholders share decision-making.

Third, companies will not be able to deliver value without physical resources like machines. These assets play a vital role in determining a business’ competitive edge. For example, many organizations cannot operate in the digital world without computers.

Fourth, the human resource department is a critical component of the internal environment. They play a prominent role in reinforcing or changing company culture through recruitment and development processes. Recruiting the right employees and developing their talents is key to creating a positive work culture. Human resource software like Cornerstone OnDemand enables companies to improve recruitment processes with a Facebook profile analyzer.

2. External Environment

The external business environment is comprised of forces around the business that affect growth and profitability. Businesses can’t control them, and therefore can’t change them. For example, new import tariffs can affect the availability and price of a product.

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The diagram illustrates how a business interacts with their external environments — it has direct interactions with the micro environment within the context of the macro environment.

Your company has an interdependent relationship with its external environment. It takes raw materials and returns products and services.

There are two groups of external environments: micro environment and macro environment.

3. Micro Environment

Micro environments directly impact your organization’s daily operations. They are your distributors, competitors, consumers, and the general public.

Suppliers are critical to a business’s ability to deliver services. For example, many e-commerce startups rely on web hosting for small business owners to ensure their websites run smoothly. Delays, interruptions, or changes in service quality contribute to poor sales and customer satisfaction. Developing a good relationship with suppliers is key to managing the quality and regular delivery of goods or services.

Competition is the order of the day. Not only are you competing with local brands but international ones as well. If you want to lead, you need to provide better customer value in price, quality, or both.

Customers form the critical external components of the business environment. They are a key driver of a company’s growth and success. In other words, the customer is king. Whether your customers are individuals or organizations, knowing their goals, expectations, and shopping behaviors is paramount to customer satisfaction and retention.

The general public is any grouping of stakeholders that can affect your day-to-day operations. They include the media, individual citizens, and professional or social associations. For instance, the media exerts influence on businesses’ brand reputation. They help form opinions that either help or hinder your efforts during a PR crisis.

4. Macro Environment

Macro environments impact your organization’s decisions. They are political, economic, social, and technological spheres.

Political climates, whether socialist or democratic, strongly impact an organization’s decision-making process. Their characteristics vary by country — some political climates are stable while others are dynamic.

Economic spheres are relative. On a broad scale, economic environments are linked to political factors. For instance, in socialist countries, the government directs quotas on production. Economic influences are connected to customers’ purchasing ability and power on a smaller scale. These include income per capita, GDP, and employment rates.

Social environments are generally stable. Components like traditions, beliefs, and values remain unchanged for long periods of time or are slow-changing. As such, social factors can have far-reaching effects on businesses.

Failure to account for social factors can lead to disastrous decisions and equal consequences, like when Nike faced backlash from the Muslim community over their Air Max shoe that resembled the Arabic word for God. Nike has since removed the offending logo from the shoe line.

The ever-changing landscape of technology makes it a dynamic environment. Innovations in technology present advantages and opportunities yet, at the same time, render existing technologies obsolete.

Therefore, decision-makers must weigh the risks and gains before adopting new technology. Still, businesses need technology to compete effectively. For instance, you need effective IT management to conduct business in today’s increasingly digital world.

What Is a Business Environment Analysis?

So far, we’ve defined the business environment and seen the different types of environments organizations interact with. Now, let us discuss business environment analysis and how it enables decision-makers to navigate the business world.

Business environment analysis is a systematic process of identifying environmental elements that affect business, assessing their impact, and developing strategies to mitigate or use them. It is also known as environmental scanning.

The business environment analysis process consists of the following steps:

1. Identifying environmental factors: Environmental factors vary by industry; for example, legal factors like health and safety are more salient in the medical field than social media management.
2. Research: Use new reports or industry content materials to gather information. Government bodies are great sources of new industry material businesses can use. For instance, the Bureau of Economic Analysis comes up with reports on personal consumption expenditures. It also releases data like personal income and international transactions every year.

International financial institutions such as World Bank, academic organizations, and think tanks such as the Institute for New Economic Thinking also release reports and working papers in light of existing challenges. In light of the COVID-19 pandemic, INET, for instance, released its interim report on the global response to the health crisis.

1. Competitor analysis: Monitor what your competitors are doing and assess their level of threat. You can compile all your data in a report like this one on a competitor’s digital presence made for a real company.
2. Forecasting: Use data from your research and competitors to brainstorm scenarios on the impact of each environmental factor. Organize your data in such a way you can properly visualize each scenario. This forecasting report by Gokce Soydemir is a great example of how you can use data to recreate potential scenes and how you should present those predictions. The report, in particular, uses data from March 2013 to make forecasts about San Joaquin Valley’s labor market and other economic variables. Notice that graphs also complement the text in the report for the viewer’s ease of understanding.
3. Strategy development: Find solutions to mitigate potential threats and capitalize on opportunities. Specify, based on your collated data, the best steps to take to ensure business growth. This report by the Federated States of Micronesia is an excellent example of a strategic development plan that helps ensure the federated states achieve economic growth and self-reliance in 20 years.

Importance of Business Environment Analysis

We’ve determined that conducting a business environment analysis helps you identify those internal and external factors with potential influence on business operations. But why does this matter?

Business environment analysis is important because it helps organizations better prepare for changes in their environments. By monitoring environmental factors, managers can anticipate threats and opportunities. Business environment analysis also empowers managers to capitalize on strengths and address weaknesses.

For instance, if you can anticipate new legislation around customer data privacy, you can consult experts on how the law will affect your use of email marketing software. You can get ahead of your competitors by implementing appropriate changes, improving your brand reputation, and increasing customer loyalty.

5 Elements of the Business Environment

Many business analysts concentrate on external environments in business environment analysis because organizations have no control over the former. Furthermore, external factors have a direct impact on a business’s operations.

There are five elements of the external environment. We’ve already touched on some of these elements, but they are:

1. Political
2. Economic
3. Social
4. Technology
5. Legal

All these elements interact with your business to varying degrees.

PESTLE Model of Business Environment Analysis

Many already use SWOT analysis to assess your work processes or programs. It helps pinpoint strengths, weaknesses, opportunities, and threats in the business environment.

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The PESTLE model conducts business environment analysis differently. Unlike SWOT analysis which assesses internal and external influences, PESTLE is primarily concerned with the external environment. PESTLE or PESTEL is an acronym for political, economic, social, technological, legal, and environmental.

PESTLE is effective because it gives businesses the bigger picture of their environment. It identifies the key environmental elements that impact business decisions.

Political

The political environment involves factors related to government action. There are two underlying factors to consider when conducting a business environment scan of political influences — overall government stability and the degree to which the government intervenes in the economy. For example, Vietnam uses directive economic planning, where the state sets requirements for production.

Additional factors are national monetary programs, trade laws, and business taxes.

Economic

Economic environments impact business growth directly. They include inflation, foreign exchange, income per capita, GDP, and unemployment rates. These affect consumers’ buying power.

Say you are a logistics software developer. When inflation rates increase, the price of your SaaS product will be affected. You can either absorb the extra expense to remain competitive or increase product pricing.

Social

The social environment consists of societal values, traditions, attitudes, and behaviors. Every country has distinct socio-cultural norms, which influence the production, sale, or advertising of goods and services. For example, Mcdonald’s doesn’t have pork items in the Middle Eastern market. Environmental analysis of social factors isn’t limited to food-based industries.

Social factors like demographics, lifestyle, and trends play a critical role in the development of software products. For instance, social media has changed buying behaviors. The rise of social commerce drove the e-commerce platform, 36etcetera, to search for WeChat integrations to enable vendors to sell on the social media app.

Technological

The technological environment entails the use of machines and software to improve modes of production and product quality. It touches every part of businesses, and the rate of advancement is astonishing. The technological factors to consider in this environmental analysis involve the availability of artificial intelligence, automation, and IT infrastructure.

Performing business environment analysis for technology helps organizations discover growth opportunities. Understanding what is available empowers you to make better choices. For instance, the Business Car Group reduced operational costs and accelerated sales cycles with a CRM system that automated customer support, accounting, and data analysis.

Legal

The legal environment refers to national laws, government policy, and industry regulations that affect how businesses work. Legal factors you should evaluate in your business environment analysis include licensing, consumer protection laws, employment laws, and intellectual property. It gets tricky for businesses targeting a global audience. You must comply with the laws of your native country and the countries where you operate.

Environmental

The ecological environment refers to the physical world, i.e., climate, water bodies, land masses, and animals. Previously, environmental influences primarily affected agricultural industries. Now, climate change is a hot-button topic, affecting every field. Modern consumers expect ethical and environmentally-conscious behavior from organizations.

Environmental facts to consider in a business environment analysis are carbon footprints, the impact of natural disasters, environmental protection laws, and sustainable/ethical production practices.

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Key Takeaways

Businesses don’t operate in a vacuum. Many factors beyond a product or service determine whether they will succeed: the political climate, available technology, cultural makeup of their target consumers, etc.

Managers and owners need to be familiar with their environment and understand how it impacts the bottom line. Business environment analysis enables companies to do this and make informed decisions.

We looked at four business environments: influential factors within companies that impact business growth (internal) and influential forces outside the business (external), which were further divided into micro and macro factors. Internal environments can be controlled, but external environments cannot.

Strategy tools like SWOT and PESTLE help business owners and managers analyze their business environment. Companies can’t control external environments, but PESTLE analysis gives them a way to anticipate and prepare for threats and opportunities by showing them where these could come from.