Assessing Changes in the Business Environment

The Relationship between Businesses and the Economic Environment

“Trickle down theory – the less than elegant metaphor that if one feeds the horse enough oats, some will pass to the road for the sparrows.”

JK Galbraith

“The market is a mechanism for sorting the efficient from the inefficient, it is not a substitute for responsibility.”

Charles HandyBUSS4.2 Economic Environment

In this topic you will learn about:Assessing the effects of the following

factors on business organisations:• Impact of economic factors• Trends in key economic variables• Globalisation of markets• Developments in emerging markets

Evaluating the strategies businesses might deploy in response to these changes.

BUSS4.2 Economic Environment

BUSS4.2 Economic Environment

The Impact of Economic Variables on a Business Organisation

Up until this point you have largely focussed on internal factors affecting business behaviour. In this unit you are going to look at the wider impacts starting with the economic environment

The economic environment consists of many key factors that influence the behaviour of businesses and their customers. These include:◦ The Business Cycle◦ Interest Rates◦ Exchange Rates◦ Inflation◦ Unemployment◦ Economic Growth

The economic environment

effects business and customer

behaviour

BUSS4.2 Economic Environment

Business CycleThe level of economic activity fluctuates over

time, this pattern is referred to as the business cycle

Economic activity is measured by GDP (Gross Domestic Product)

GDP is the total value of a country’s output in a year

Real GDP takes into account inflation. If GDP growth is 5% and inflation 2% real GDP growth will be 3%.

There are four main stages to the Business Cycle:

Real GDP

Time

Boom

Recovery

Recession

Slump

Trend rate of economic growth

BUSS4.2 Economic Environment

Business Cycle - Boom

A period of high levels of economic activity

Characterised by:

High rate of economic growth

High demand

Low unemployment

Inflationary pressure

Labour skills shortages

High confidence in the economy

Capital Investment is high

Once you have studied each of the economic variables in turn you

may wish to revisit the business cycle to

discuss why some of these characteristics of a boom in time lead to

a downturn

BUSS4.2 Economic Environment

Business Cycle – BoomBusiness impact

Firms struggle to find skilled workers

Capacity utilisation is close to full capacity due to the high rate of economic growth

Demand is more price inelastic - price becomes less significant

Quality will be seen as more attractive

More difficult to retain staff as firms compete for workers – wages are bid up

BUSS4.2 Economic Environment

Business Cycle - Recession

The rate of economic growth starts to fall in a downturn

If real GDP falls for 6 months then this is known as a recession

Characterised by:

Demand falls

Unemployment begins to rise

Some firms will go out of business

Confidence in the economy is low and most firms will reduce investment

1979 saw the start of Britain’s decline into a recession – mirrored in the music of the dayGhost Town The Specials

The Government state that recession is officially two quarters of negative economic growth. However, it is often regarded as a period of low economic growth.

The worst recession in the UK since

1979

BUSS4.2 Economic Environment

Business Cycle – RecessionBusiness impact

Firms will rationalise – laying off workers and reducing capacity

Cost minimisation will become a key factor

Demand is more price elastic - price becomes more significant

‘Value for money’ will be seen as more attractive

Staff fear for their jobs and motivation will be affected

Corus job losses

What actions has the business taken to try and avoid job losses?

What is the likely knock on effect of the job losses in the local area?

BUSS4.2 Economic Environment

Business Cycle - Slump

The bottom of the business cycle which represents a period of serious economic decline

Characterised by:

Low or negative growth

Demand and inflation are low

Unemployment is high

Confidence in the economy is low

High rate of bankruptcy

Why is the housing market frequently quoted as a key

indicator of economic activity?

BUSS4.2 Economic Environment

Business Cycle – SlumpBusiness impact

Many firms have gone out of business – less competition for those who survive

Many more are fighting for survival

Price is pre-eminent for many firms

However, less competition leads to monopoly and oligopolistic (few firms in an industry) markets

Wage costs are lower as too many workers vie for too few jobs

BUSS4.2 Economic Environment

Business Cycle - Recovery

When there are signs that economic growth is starting to rise, often referred to as the ‘green shoots of recovery’

Economic growth starts to rise

Demand increases

Unemployment falls

Inflation starts to rise

Confidence in the economy increases

Capital Investment increases

Why is business confidence so

important for a recovery?

BUSS4.2 Economic Environment

Business Cycle – RecoveryBusiness impact

Firms will take on more workers

Capacity utilisation increases

Investment in all areas starts to increase

Price begins to be a less important factor

BUSS4.2 Economic Environment

Evaluating strategies that businesses might deploy in response to changes in the business

cycle

Recovery/BoomIncrease capacity utilisation – can the firm afford to take on new workers and increase production? This will depend on other factors such as the finance available, particularly in the short-run

Increase capacity – can the firm afford to invest in capital equipment? This will require longer term sources of finance. Gearing will be a significant issue here

Target new markets – Ansoff’s Matrix can be used to look at business strategy here. The firm might develop new products with a high positive income elasticity e.g. luxury goods

Increase price – what is the price elasticity of the product? As the economy grows price become less important to customers

BUSS4.2 Economic Environment

Evaluating strategies that businesses might deploy in response to changes in the business

cycle

Recession/SlumpCut capacity – there is an opportunity cost involved. Will the recession be short lived? Once changes have been made they are often difficult to reverse

Lay off workers – this can cause demotivation and initial cash flow problems with high redundancy costs

Target new markets – Ansoff’s Matrix can be used to look at business strategy here

Reduce price – what is the price elasticity of the product. This could lead to price wars where only the consumer benefits. Not everyone suffers in a recession! Are the firm reducing the price of a price inelastic product?

Go on a buying spree! – takeover activity often increases in a recession – other companies are suddenly a bargain!

BUSS4.2 Economic Environment

Economic Variables - Interest Rate

What is it?

The price of money - the cost of borrowing or the reward for saving money

How do interest rates affect a business? Gearing

firms that have high gearing are sensitive to interest rates

Supply if the cost of borrowing increases it becomes more expensive to invest in

capital equipment B2B (Business to Business) transactions will fall as firms buy less capital goods

and there will be less capacity in the economy

Demand higher interest rates will mean that consumers have less disposable income

e.g. higher mortgage payments and therefore fall in demand for other products

Exchange rates higher interest rates mean that foreign investors will invest in UK banks for

higher returns an increase in demand for the £ will see its value appreciate – making exports

dearer

How do interest rates effect consumer spending? Gross wage – compulsory deductions e.g. tax, NI and

pensions = Net or take home wage. We call this disposable income.

Net wage – compulsory payments e.g. mortgage, loan repayments, insurance etc = Discretionary income i.e. the proportion of our wage that we spend at our discretion

As interest rates go up our discretionary income goes down

Interest rates also affect our ability and willingness to buy on credit

BUSS4.2 Economic Environment

Look at the items of expenditure below. Rank these in an order to show how likely it is demand will fall for them if interest rates go up.

Justify your ranking.

Milk, Cigarettes, Daily Newspaper, Freezer, Petrol, Cinema tickets, Restaurant meal, New car, School shoes, Designer jacket, Gym

membership, Packet of crisps, Sofa, Light bulbs, Organic vegetables, DIY equipment

BUSS4.2 Economic Environment

Economic variables - Exchange Rates

What is it?

The price of one currency in terms of another e.g. £1 = $1.50

An increase in the value of a currency is called an appreciation andmeans the currency is worth more e.g. £1 = $1.60

A decrease in the value of a currency is called a depreciation and means the currency is worth less e.g. £1 = $1.40

How do exchange rates affect a business?

SPICED (strong pound: imports cheaper, exports dearer) Firms that import will be able to buy cheaper raw materials and

finished goods Firms that export will see less demand

WPIDEC (weak pound: imports dearer, exports cheaper) There will be greater demand from abroad for UK goods Input prices will increase if raw materials are imported If the firm has a price inelastic product it will be able to pass the

increase in costs onto the consumer

Explain why a depreciation of the Pound will lead to increased tourism from the EU

BUSS4.2 Economic Environment

Economic variables - Inflation

What is it? A general rise in prices or a fall in the value of moneyThere are two main types of inflation:

• Cost push – an increase in input prices e.g. raw materials and wages

• Demand pull – an increase in demand allowing firms to raise prices

There are two main measurements: Retail Price Index (RPI) – a measurement of a ‘basket’ of

goods and services representative of what people buy in the UK

Consumer Price Index (CPI) – similar to RPI but mainly excluding housing costsExplain the relationship between

inflation, pay and cost of living.What happens to inflation in a

recession?

BUSS4.2 Economic Environment

Economic variables - Inflation

How inflation affects a business: The Government have set an inflation target of 2%. The

Bank of England’s Monetary Policy Committee (MPC) meet once a month to decide the Bank’s Rate of Interest. If CPI is too high they might raise interest rates to reduce the rate of inflation

Increased costs due to higher inflation can be passed onto the consumer if the product is price inelastic. If not the firm will have to try and absorb the increased costs through lower profit margins

Clearly, this has an impact on the pricing strategy of a firm. Some firms will reduce the supply of the product, having a major affect on operations management as capacity is reduced and the firm rationalises with a greater focus on cost minimisation

It becomes increasingly difficult to maintain competitiveness. Demand will fall if the firm has to raise price. If it exports then it will see customers move to companies abroad where prices are not rising as fast

BUSS4.2 Economic Environment

Economic variables - Unemployment

What is it? Those people looking for work who cannot find a job. It can be measured in two main ways:

• Claimant count – those claiming Unemployment Benefit• Labour Force Survey – those without a job, want a job, have

sought work in the last 4 weeks and are available to start work in the next 2 weeks

http://www.statistics.gov.uk/downloads/theme_labour/unemployment.pdf

How unemployment affects a business: Skills shortage/surplus – too few workers will lead to less suitable

skills for the position, too many plenty of choice Demand – high unemployment leads to less demand and vice-versa High/low costs – wage rates are affected by the number of people

available for a position

Use the evidence presented in these BBC clips to discuss the affects listed above

BUSS4.2 Economic Environment

Economic variables - Unemployment

Types of unemployment:

Structural – this occurs because of fundamental changes to the economy and whole industries are in decline

Cyclical – this is linked to the business cycle and occurs due to the position on the cycle e.g. slump equals high unemployment

Frictional – this occurs when people are unemployed as they are moving between jobs. With a job awaiting them, this type of unemployment does not have a major impact on the economy

Seasonal – as we move through the seasons different kinds of job are created or lost e.g. holiday jobs due to the summer

The Chief US Economics advisor gives advice on economics

BUSS4.2 Economic Environment

Economic variables - Economic Growth

What is it?

A rise in the value of Gross Domestic Product (GDP)

This measures the value of goods and services produced in an economy each year.

How economic growth affects a business: Demand – consumers will have more disposable income e.g.

higher wages. Firms will have higher profits which can be reinvested

New business start-ups – more new firms will be created due to confidence in the state of the economy

Inflation – higher demand in the economy can lead to skills shortages and demand-pull inflation

Negative economic growth occurs when the value of GDP starts to fall. If this occurs for at least two quarters of a year i.e. 6 months we are officially in a recession

BUSS4.2 Economic Environment

Globalisation of markets

Globalisation is the integration of international economies leading to a world market in goods and services

This has meant that markets are increasingly global i.e. trading and/ or operating internationally

Greater interdependency amongst countries – they rely on each other

Globalisation has led to the movement and exploitation of factors of production by Multinational Corporations (MNCs) around the world

Remember, questions should be answered about the impact on the firm NOT the impact

on the UK economy

BUSS4.2 Economic Environment

Globalisation of marketsBenefits of Globalisation

Opportunities to sell into new markets

Economies of scale as the firm grows globally

Global marketing strategies can be used

Cheaper raw materials from low cost countries

Cheaper labour costs abroad

Free movement of labour providing cheap labour in the UK

Off-shoring provides greater scope for optimal location

Look at one of the UK’s large supermarkets. Choose three different products. How have the factors of production used in putting these products into the supermarket been exploited on a global basis?

BUSS4.2 Economic Environment

Globalisation of markets

Disadvantages of Globalisation Increased competition – although this can make firms more

efficient

‘Global localisation’ – altering products to meet local tastes - may be required to meet local cultures

Communication and transport problems

Firms can gain a bad reputation for making UK workers redundant

Exploitation of foreign workers can lead to criticism of being unethical

Exploitation of the global environment can lead to bad publicity

Are business leaders in France right to fear

globalisation?

HSBC The world’s local bank.

Can Global localisation be a strength of a business?

BUSS4.2 Economic Environment

Developments in emerging markets

An emerging market is a country with low to middle per capita income (Average income per person) Antoine Van Agtamael - World Bank (1981)

This refers to 80% of the World’s population but only 20% of its countries.

Emerging markets are seeing rapid growth through economic reform. They are emerging from ‘closed’ economies (no international trade) to ‘open’ economies (increasing international trade)

This encompasses the BRIC countries (Brazil, Russia, India and China) as well as smaller nations such as Pakistan, Peru and Singapore

HSBC The world’s local bank moves into emerging markets

BUSS4.2 Economic Environment

Developments in emerging markets

How can an emerging market benefit UK firms?

In terms of the Boston Matrix many emerging markets can be seen as rising stars. They have in common:

Rapidly rising consumer incomes

Fast growing markets

Exploitable natural resources

Exploitable cheap labour

Rising StarHigh Market GrowthHigh Market Share

BUSS4.2 Economic Environment

Developments in emerging markets

However emerging markets can cause UK firms problems

In terms of the Boston Matrix emerging markets can also become problem children or even dogs:

Poor infrastructures e.g. transport and communication

Political instability

Accusations of exploitation from an ethical and environmental perspective

Cultural and legal differences

ACTIVITY – Economic Environment Terminology

BUSS4.2 Economic Environment

You have been introduced to a lot of new terminology in this unit, it is important that you are confident with the language of accounts before moving onto the next unit.

1. Draw a mind map to summarise the terminology you have been introduced to in this unit, make sure that all the correct terms are included, with explanations and examples where appropriate.

2. As a class individually draw a grid with 9 squares in it - put in 9 words to do with the economic environment in a random order

3. Nominate one person or the teacher to call out words or definitions. As they appear on your grid cross them off as if playing bingo.

Essay

In 2007 Costa Coffee opened its first store in China with plans to open a total of 300. Chief executive Alan Parker said "China is a very attractive market, making this a major deal for Costa.” With reference to Costa Coffee and/or other businesses you have studied to what extent do you agree that emerging economies are attractive markets for global expansion. Justify your answer.

BUSS4.2 Economic Environment