Understanding that businesses operate within an external environment

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The external environment can affect:

Costs:

Costs are the value paid or to be paid for the acquisition of goods and services by businesses

Demand:

The amount customers are willing and able to buy at a set price at any given point in time

External factors:

Competition:

The number and relative power of firms trading in the same or similar markets

Effect on cost: If there are many competitors in the market this will increase the selling power of the supplier as they will have a range of firms wanting to buy their goods or services. This can therefore push costs up. Competition may attract new suppliers into a market increasing the availability and therefore driving costs down

Effect on demand: Competition can encourage firms to compete on price therefore lowering prices overall and increasing demand in the market. A number of firms competing may see a spread in demand between firms, reducing the market share of each firm if the market size remains unchanged.

Market conditions:

The defining characteristics of the market, e.g. level of sales, trends and degree of competition.

Effect on cost: Market conditions will affect the demand for supplies and therefore directly impact on costs. If the market is in decline, costs may be lowered as firms try to maintain sales. If there is a high level of demand then supplies may be in short supply allowing suppliers to increase costs.

Effect on demand: The level of demand will be a clear indicator of market conditions. if the market is growing demand will be increasing and vice versa. Buoyant market conditions may act as a signal for new businesses to enter the market in anticipation of a further increase in demand

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External Factors (Cont.)

Incomes:

The earnings of consumers that will directly influence spending power

Effects on costs: Rising incomes may be as a result of higher wages which are a cost to a business. This may be due to government increasing the national minimum wage.

Effect on demand: Incomes directly affect consumers spending power. If incomes are rising this could lead to a rise in demand as consumers have higher discretionary incomes.

Interest rates:

The cost of borrowing or the reward for saving

Effects on costs: Interest rates will affect the cost of borrowing by businesses. If interest rates go up so will the interest section of repayments on bank loans or overdrafts. This will increase the fixed costs of a business. Businesses may also find that suppliers try to pass their own higher costs in the form of higher prices further increasing costs.

Effect on demand: If interest rates increase this encourages consumers to save and discourage spending. A fall in interest rates will have the opposite effect. High interest rates may therefore lead to a fall in demand, especially for items where consumers spend on credit. This will also be true of luxury goods where consumers may use savings to make a purchase.

Demographic factors:

The statistical characteristics of the population

Effects on costs: Rising net migration has increases the size of the workforce in the uk. This has driven average wage costs down lowering the cost of production. Changes in UK demographics, including migration and the size and age of the population has increased costs to the public sector.

Effects on demand: Migration has seen an increase in demand for a wide range of goods and services e.g. housing, public transport and healthcare. Demographics also influence the types of products demanded e.g. changing taste of a more diverse nation and different demands from an ageing population.

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External influences (cont.)

Environmental issues and fair trade:

The variety of factors that impact on the environment due to the operation of businesses e.g. pollution

Effect on costs: Fairtrade may increase costs as a business is making a commitment to pay suppliers a fair price, hence increasing the cost of raw materials. Concern for environmental issues may also increase costs of production in terms of safe disposal of waste or upgrading of equipment to reduce emissions. Concern for environmental issues may also lower costs in terms of lower energy usage or avoidance of fines.

Effect on demand: Businesses can use environmental issues and fair trade as a Unique Selling Point or a recognisable feature of a brand leading to an increase in demand. If increased costs are passed on to the consumer in the form of higher costs this may lead to a fall in demand.