The External Environment: Economy, Ethics & Globalisation

The External Environment

No business operates in a vacuum. Decisions are shaped by forces outside the firm's control — the external environment. A business cannot stop interest rates rising or a recession hitting, but it can plan for them. This chapter looks at the economy, government and the law, ethics and the environment, and globalisation.

Key terms External environment — the outside factors (economic, legal, social, technological) that affect a business but which it cannot control.

Stakeholder — any group with an interest in a business, such as customers, employees, the government and the local community.

Economic factors

The wider economy affects every business through its costs, its prices and how much customers are willing to spend.

Interest rates are the cost of borrowing money (and the reward for saving). When interest rates rise:

Loans and mortgages cost more, so consumers have less spare income and spend less.
Firms find borrowing to invest more expensive, so expansion may be delayed.
Businesses with existing loans face higher repayments, raising costs.

A fall in interest rates does the opposite — borrowing and spending tend to increase. Businesses selling expensive items bought on credit (cars, furniture) are especially sensitive.

Inflation is a sustained rise in the general level of prices, measured as a percentage per year. Inflation raises a firm's costs (raw materials, wages) and can erode customers' purchasing power. Some inflation is normal; high inflation creates uncertainty and squeezes profit margins.

Taxation transfers money from businesses and individuals to the government:

Unemployment is the number of people willing and able to work who cannot find a job. High unemployment means weaker consumer demand, but it can make hiring easier and cheaper for firms because more workers are available.

Watch out Don't say a factor is "good" or "bad" in isolation. A recession is bad for a luxury car maker but can help a discount supermarket as shoppers trade down. Always link the factor to the specific business in the question.

The business cycle

Economies do not grow at a steady rate. They move through a repeating pattern called the business cycle (or economic cycle), measured by changes in GDP (gross domestic product — the total value of output).

Boom — fast growth, high spending, low unemployment, rising prices. Firms expand and profits are high, but costs rise too.
Recession — falling output for two or more quarters; spending drops, unemployment rises, some firms fail.
Slump / trough — the low point, with weak demand.
Recovery / upswing — confidence and demand return; the cycle begins again.

Real world In the 2008 global financial crisis many economies fell into recession. Discount retailers and "value" brands grew as households cut back, while sales of luxury goods and new cars fell sharply — a clear example of how the same event affects different businesses differently.

Exchange rates

An exchange rate is the price of one currency in terms of another, for example £1 = $1.25. Exchange rates matter to any firm that imports raw materials or exports finished goods. A useful memory aid is SPICED:

Exam tip Remember SPICED: Strong Pound = Imports Cheaper, Exports Dearer. So a weak pound makes exports cheaper (good for exporters) but imports more expensive (bad for importers). State whether the firm in the question is mainly an importer or exporter before judging the effect.

Government influence and legislation

Governments shape business behaviour through laws that protect different stakeholders. Breaking the law can mean fines, compensation and serious damage to reputation.

Consumer protection — goods must be safe, as described, and of satisfactory quality; misleading advertising is banned. This builds customer trust but raises compliance costs.
Employment law — covers minimum wages, contracts, protection from unfair dismissal and rules against discrimination. It protects workers but increases labour costs and paperwork.
Health and safety — firms must provide a safe workplace, training and protective equipment. This reduces accidents but adds cost.
Environmental law — controls pollution, waste and emissions. Firms may have to invest in cleaner processes.

Key terms Legislation — laws passed by government that businesses must obey.

Minimum wage — the lowest hourly pay an employer is legally allowed to give a worker.

Ethics and business

Business ethics are the moral principles that guide how a firm behaves — doing what is right, not simply what is profitable or legal.

Firms often face an ethics–profit trade-off. An ethical choice can raise costs in the short term:

Paying suppliers in developing countries a fair price rather than the cheapest possible.
Refusing to use child labour or unsafe factories.
Sourcing materials sustainably instead of from the cheapest source.

These choices may lower short-term profit, but they can raise profit in the long run by attracting ethically-minded customers, improving reputation and helping recruit and keep staff. Acting unethically might cut costs but risks boycotts and lasting reputational harm.

Corporate social responsibility (CSR)

Corporate social responsibility means a business accepting responsibility for its impact on society and the environment — going beyond the minimum the law requires.

CSR activities include reducing waste, treating workers well, supporting local communities and using ethical suppliers.

Environmental issues and sustainability

Business activity can harm the environment through pollution, waste, resource depletion and carbon emissions. Sustainability means meeting today's needs without damaging the ability of future generations to meet theirs.

Firms respond by recycling, cutting energy use, using renewable materials and designing longer-lasting products. Pressure comes from customers, governments and pressure groups. Going green can raise costs but also cut waste bills, attract customers and avoid fines — and increasingly it is expected by stakeholders.

Globalisation

Globalisation is the growing integration and interdependence of the world's economies, so that businesses trade and operate across national borders more freely.

A multinational company (MNC) is a business that has operations (factories, offices or stores) in more than one country — for example global car, technology and food brands.

Key terms Imports — goods and services bought from other countries.

Exports — goods and services sold to other countries.

Multinational — a firm that produces or sells in more than one country.

Benefits of trading internationally:

Access to much larger markets, raising potential sales and profit.
Economies of scale lower the average cost per unit.
Cheaper raw materials and labour from abroad.
Spreading risk across several markets, so a downturn in one country hurts less.

Drawbacks of trading internationally:

More competition from foreign firms.
Exchange-rate movements make revenues and costs less predictable.
Trade barriers such as tariffs (taxes on imports) and quotas (limits on quantity) raise costs.
Cultural, language and legal differences are hard to manage.

Worked example A UK toy maker exports to the USA, pricing a toy at £10 when £1 = $1.30, giving a US price of $13. The pound then falls to £1 = $1.10.

The same £10 toy now sells for only $11 in the USA.

Because the pound is weaker, the firm's exports are cheaper abroad and likely to sell in greater volume — good news for this exporter (remember SPICED: a strong pound makes exports dearer, so a weak pound makes them cheaper).

Technology and e-commerce

Technology is a major driver of globalisation. E-commerce — buying and selling online — lets even small firms reach customers worldwide 24 hours a day without needing physical shops abroad.

Benefits: lower costs (no shopfronts), a global customer base, easy price comparison and round-the-clock trading.
Drawbacks: intense online competition, the cost of websites and delivery, cyber-security risks, and the loss of personal contact.

Exam tip "External environment" questions usually reward application and judgement. Pick the factors that matter most to the business in the case, explain the chain of effects ("interest rates rise → repayments rise → costs up → profit falls"), and finish with a supported conclusion about the overall impact.

Chapter summary

The external environment (economic, legal, ethical, environmental and global factors) is outside a firm's control but must be planned for.
Key economic factors: interest rates, inflation, taxation, unemployment and the business cycle (boom → recession → slump → recovery).
Exchange rates affect importers and exporters — remember SPICED.
Legislation protects consumers, employees, health and safety, and the environment.
Ethics and CSR mean going beyond the law; there is often a short-term profit trade-off but long-term gains.
Sustainability balances business activity with protecting the environment.
Globalisation, multinationals, e-commerce and technology open up large markets but bring more competition, trade barriers and currency risk.