3.1.3 - The external business environment

Competition and market conditions

The external environment includes developments outside the business that influence its customers, resources and opportunities.

Competition is rivalry between businesses seeking customers or other scarce resources. A new competitor selling similar products may draw customers away, reducing the existing firm's demand at its current price. The firm may cut price, improve quality or promote its product. A price cut can defend sales volume but reduce revenue per unit, while promotion and quality improvements can increase costs. The overall profit effect depends on both demand and expenditure.

Competition need not be only about price. Illustrative case: a repair shop faces a rival offering faster appointments. Customers may switch even though prices are similar. Improving scheduling could protect demand, but employing another technician costs money. A business with distinctive expertise may face less direct switching than one selling an easily comparable service. The effect therefore depends on substitutes, customer loyalty and the value of the competing offer.

Firms also compete for resources. Several expanding businesses bidding for a limited supply of experienced staff can push up wages. Competition for premises or scarce materials can raise input costs. In contrast, more competition among the business's suppliers may improve the purchasing terms it can obtain. Identify which market the competition occurs in before predicting a cost effect.

Market conditions include the size and growth of demand, consumer confidence, the number and strength of rivals and the availability of supplies. An expanding market can provide more sales opportunities without every firm taking customers from rivals. A contracting market makes existing capacity harder to fill. Product demand can also change with seasons, tastes or new technology: demand for one product may decline while a substitute market grows.

Illustrative case: demand falls for a holiday accommodation provider during a period of weak consumer confidence. It may discount empty rooms, but many property and staffing costs remain payable. Falling revenue therefore need not be matched by an equal fall in costs. Alternatively, strong demand could increase room sales while raising recruitment and cleaning costs. Market growth is an opportunity to assess, not a guarantee of higher profit.

Managers respond by gathering market evidence, comparing options and assessing whether their resources can support the response. A single competitor's action is not enough to predict every customer's reaction. Demand estimates and cost forecasts should state the period and assumptions.

On 25 April 2019, the Competition and Markets Authority blocked the proposed Sainsbury's–Asda merger, finding that it would raise prices and reduce competition. The regulator's decision constrained the firms' growth plans because consumers' access to competing suppliers mattered as well as the companies' expected benefits. CMA merger decision.

Incomes and interest rates

Changes in customers' incomes and the cost of borrowing can affect sales demand as well as a business's own expenditure.

When disposable income rises, customers can afford more purchases after tax and essential commitments. Demand for many products increases, especially discretionary services or premium alternatives. Restaurants, for example, may receive more bookings as customers can afford to eat out more often. The effect depends on their customers and products: higher incomes could reduce demand for an economy product if customers switch to a preferred alternative. Do not assume every business benefits equally from an income rise.

Falling incomes can encourage customers to delay durable purchases, choose lower-priced alternatives or reduce spending. A luxury-gift retailer may lose sales while a low-cost repair service gains customers who postpone replacement purchases. A business serving mainly other businesses can still be affected: its customers may reduce orders because their own final customers are spending less.

Interest is the price paid for borrowing money, commonly expressed as a percentage rate over a period. Higher interest rates increase borrowing costs where loan terms expose the borrower to the change. This can reduce profit and cash available for other uses. A firm with a fixed-rate loan may not face an immediate change on that loan, while a debt-free firm may be affected mainly through customers and competitors.

An increase in annual borrowing cost

A business has a constant £200,000 loan balance with simple annual interest changing from 5% to 7%.

1. Calculate the original annual interest:

1. Calculate the new annual interest:

1. Subtract to find the extra cost:

The rate rises by 2 percentage points, a 40% increase relative to 5%. These measures describe different things.

A lower rate on a smaller loan

A retailer's constant £150,000 variable-rate loan moves from 8% to 6.5%, with simple annual interest.

1. Original annual cost:

1. New annual cost:

1. Annual saving:

This saves borrowing cost while the loan balance is unchanged; it is not a £2,250 loan repayment.

Higher rates can also reduce customers' demand. Borrowing to buy cars or equipment becomes more expensive, while mortgage payments may leave households with less disposable income. Saving can become more attractive, encouraging postponed spending. A seller of credit-financed products may therefore experience both higher costs and lower sales. Lower rates can reverse some of these pressures, but customers may still hesitate if their future income is uncertain.

Income and interest-rate effects interact with competition and the market. A firm may absorb a borrowing-cost increase to retain customers, or attempt to raise its price if demand is strong. Analyse the particular firm's debt exposure and customers rather than making a universal prediction.

Demographic change and business activity

Demographic factors describe the composition and distribution of a population, such as age, household size and location.

These factors influence who potential customers are and what they need. More families with young children in a locality may increase demand for childcare and family-sized housing. A larger older population may create opportunities for accessible transport or services suited to particular needs. Such changes do not establish that every member of an age group wants the same product: income, health, preferences and competition still matter.

Population movement can change the size of a local market. Illustrative case: a housing development brings new households to a town. A food shop may expect additional demand, but must investigate residents' purchasing patterns and rival shops. A fall in the local population could reduce sales and leave a business's premises underused. National population growth would not automatically solve a decline in one catchment area.

Demographic change also affects the workforce. More people with the required skills entering an area can widen the recruitment pool. Retirements or a falling working-age population can make particular skills scarcer, increasing recruitment time, training requirements or wage pressure. Migration can add customers and workers, but the effect depends on skills, location and whether employers can match people to jobs. Avoid treating a demographic label as evidence of a person's skills or preferences.

Businesses may have to alter operations. Providing accessible premises or different opening hours can involve investment and staffing costs while improving access to customers. A retailer adapting pack sizes to smaller households might change packaging and production arrangements. Demand opportunities and cost changes should therefore be considered together.

Demographic evidence is often useful for long-term planning because some changes occur gradually. Forecasts still depend on assumptions about migration, births, household formation and local development. Managers should compare suitable locations and time periods, and use direct customer research to test whether a population change translates into demand for their specific offer.

Environmental issues and fair trade

Environmental concerns and expectations of fair treatment in trade can affect the products customers choose and the way a business obtains resources.

Environmental issues include waste, emissions, resource depletion and the effects of production or transport on surroundings. Customers may favour a product with less waste or a credible lower-impact method. This can increase demand or support a price premium, but customers differ in their willingness and ability to pay. A claimed environmental benefit must be credible; unsupported claims can damage trust.

Businesses may change materials, energy use, packaging or transport. These changes can raise costs initially: new equipment, supplier checks or more expensive inputs require resources. Some changes reduce costs over time. Less material waste means fewer inputs purchased for the same saleable output, and lower energy consumption can reduce operating bills. A response should compare the investment and running costs over a stated period rather than assume every environmental improvement is a net expense.

Fair trade concerns fairer terms and treatment for producers and workers in supply chains, including fair payment and appropriate working conditions. A business may pay more for inputs, choose suppliers using social criteria or spend time verifying standards. It may gain more dependable supply relationships and appeal to customers who value those commitments. The commitment also concerns the treatment of suppliers, even where it cannot be shown to maximise profit.

Illustrative case: a chocolate producer compares two suppliers. A lower-price supplier offers a lower immediate purchasing cost, while a supplier with credible fair-trade practices may better fit the firm's ethical objective and customers' expectations. Paying more could reduce profit if prices and volume stay unchanged. It could also support loyalty or reduce disruption if the relationship becomes more reliable. Neither result should be assumed without evidence.

Ethical and competitive effects can reinforce or conflict with each other. A small firm may find verification and redesign relatively costly; a large firm may spread some administrative costs across more sales. A premium seller may recover costs through price more readily than a seller whose customers are very price-sensitive. Managers need to assess the credibility of claims, customer response, supplier capacity and financial feasibility.

The external environment creates the pressure, but a business's response reflects its choices. Customer concern does not force every firm to adopt the same packaging or supplier; mission, resources and competitive position influence what can be done.