CHAPTER - 3

Business Environment
 Meaning of Business Environment
 Business environment refers to all the external forces— including
economic, social, political, technological and legal—that affect the
performance of a business organisation.
 These forces can affect the performance of the organisation either in a
positive or in a negative manner. For example, a change in consumer’s
tastes and preferences in favour of a firm’s product increases the demand
for its product. On the other hand, political instability can have an
adverse impact on its performance.
 External forces are outside the purview or control of an organisation but
affect its performance.
 Features / Characteristics of Business Environment
The following diagram depicts the various features of a business environment.
1) Aggregate of external forces: A business environment is the aggregate
of all the external forces such as individuals, consumers, government and
legal matters that affect the performance of an organisation either
positively or negatively.
2) Interrelated: The different forces of a business environment are
interrelated with one another. For example,
 in income of the consumers   in demand for consumer
durables
3) Ever-changing: A business environment is dynamic. For example, the
consumer’s tastes and preferences, technology, political conditions, etc.,
change continuously.
4) Uncertain: The dynamism in the forces of a business environment implies
that they are highly uncertain and cannot be predicted easily.
5) Complex: As a business environment is the aggregate of different
interrelated forces, understanding it is quite difficult.
6) Relative: A business environment is relative in nature and differs from
 one region to another depending on various factors. For example, political
conditions, religious beliefs, etc., are different in different regions.

 Specific and General Business Environment

 Specific environment: A specific business environment refers to a
business environment in which an organisation is acted upon by external
forces specific to the particular organisation and its performance is affected
directly by these forces. For example, a change in consumer tastes and
preferences for the products of a business enterprise directly affects the
demand.

 General environment: A general business environment refers to a

business environment in which general external forces affect the
performance of all the organisations simultaneously. These forces affect a
particular organisation only indirectly. For example, a change in political
conditions affects the performance of all the organisations in the region
simultaneously.

 Importance of Business Environment

The following diagram highlights the importance of a business environment.
As an organisation is constantly affected by various external forces, an
understanding of these forces is necessary for its successful functioning. The
following points highlight the importance of studying the business environment.
1) Identification of opportunities: An analysis of a business environment
enables an enterprise to identify various positive opportunities and thereby
take first advantage in its competition with other companies.
2) Identification of threats: A study of a business environment can help a
company analyse positive opportunities, but this study can also help it
identify various threats or negative signals and take preventive measures
timely and appropriately.
3) Accumulation of useful resources: A business environment, on the
one hand, provides an organisation various inputs required for its
functioning, and on the other hand, acts a source of demand for the goods
and services produced by it. Thus, it is important for an organisation to
understand its environment and use those resources from it that are
required for the production of the goods and services in demand.
 4) Adjustment to changes: A careful study of a business environment
helps an organisation in dealing with various changes in the external forces
better.
5) Formulation of plans and policies: Through a study of a business
environment, an organisation can identify various threats and
opportunities to it, and accordingly frame suitable plans and policies.
6) Improvement in performance: Organisations that carefully study their
business environments and accordingly adopt suitable plans and policies
are better able to improve their performance in the long run.

 Dimensions of Business Environment / Components of Business Environment /

Factors Affecting Business
The term ‘dimensions’ refers to the various external forces that make up a
business environment. There are six broad dimensions of business.

The following are the dimensions of a business environment.

Dimension Consists of Example
Changes in economic Interest rate, income, stock
Economic
variables market indices
Social forces Customs, traditions,
Social
religious celebrations
Technological changes and Technology used in the
Technological improvements production of a product
becoming obsolete
 Laws passed by the Laws such as Companies
Legal
government Act and Trade Union Act
Changes in political A change in the
Political conditions and situations government bringing a
change in rules and policies

 Macro-economic Factors that affect the functioning of Business

1) Phase of economic development: Business organisations are directly

influenced by the phase of development of the economy in which they operate.
The policies followed by business organisations in developed countries are
different from the policies followed by companies in developing countries.
2) Economic policies of the government: Economic policies such as fiscal
policies and monetary policies directly affect the functioning of business
organisations. For instance, liberal monetary policies (such as a reduction in
interest rates) have a positive impact on business organisations.
 3) Structure of the economy: The type of structure, namely, capitalist,
socialist or mixed economic structure, governs the business opportunities in a
country.
4) Infrastructure: The availability (or lack) of infrastructure facilities has a
positive (or negative) impact on the functioning of a business enterprise.
5) Economic indicators: Economic indicators such as national income and
rate of saving and investment depict the level of economic activity and,
thereby, the availability of various business opportunities.

 Economic Environment in India at the Time of Independence

At the time of Independence, the economic environment in India can be rightly
said to have been stagnant. The following are the characteristics of the economic
environment in India at the time of Independence.
1) Agriculture was the dominant economic activity.
2) Nearly 70% of the total population was employed in agriculture.
3) More than 85% of the total population lived in villages.
4) Obsolete and backward technology was used in production (in both
agriculture and manufacturing).
5) There was a lack of a good public health care system.
6) Communicable diseases were widespread.

 Major Objectives of Development Plans in India

Development plans in India were formulated with the following four broad
objectives.
i. Rapid economic growth
ii. Self-reliance
iii. Equity
iv. Development of socialist pattern
 Objective Meaning
Increase in the GDP i.e., over time a
Rapid economic continuous increase in the market value of
growth the goods and services produced in the
economy during an accounting year
Discouraging imports of those goods that
Self-reliance
could be produced domestically
Equitable distribution of GDP such that
Equity the benefits of higher growth are shared by
all sections of society
Socialist pattern Focus on equality and overall welfare

Note: In accordance with these objectives, a major step taken by the government was
to increase the role of the public sector while restricting the private sector. A large
number of industries were reserved for the public sector. On the other hand, the
operations of the private sector were highly restricted through regulations and controls
such as licences and permits. However, the system did not yield a positive effect, and
India faced a severe economic crisis in 1991.

 Major Features of the Economic Crisis in 1991

1) High fiscal deficit amounting to 7% of the GDP.
2) Increasing internal debt (approximately 50% of the GDP). In addition,
the interest payments accounted for more than 39% of the total revenue
collections of the central government.
3) Low production in the agriculture and industrial sectors.
4) High inflation rates (13-14%).
5) Depreciation in the value of the rupee against the US dollar.
6) Fall in the foreign exchange reserves to an extremely low level.
 7) Failure to meet international financial obligations, thereby forcing
the Reserve Bank of India (RBI) and the State Bank of India (SBI) to
pledge nearly 47 tonnes of gold in the international market.
8) Considerable fall in the country’s credit-worthiness rating,
making it difficult for the country to go in for fresh borrowings.
9) Low gross national product (GNP) growth rate (1.4%).

To overcome the crisis, the Union Government introduced a host of reform measures.
The most important was the introduction of the New Economic Policy, 1991.

 New Economic Policy (NEP), 1991

As a part of the reforms, the government introduced the New Economic Policy
(NEP) in July 1991. The following are the broad features of the policy.

1) Delicensing: The number of industries under compulsory licensing was reduced

to only six. That is, a licence was required for the establishment of a new
business in only six industries.
2) Dereservation: The number of industries exclusively reserved for the public
sector was reduced to only four (strategic industries).
3) Disinvestment: To further minimise the role of the public sector, disinvestment
was taken up in many public sector units.
4) Increase in foreign equity participation: Foreign equity participation was
increased, and 100% foreign direct investment (FDI) was allowed.
5) Liberalisation of the import of technology: Automatic permission was
granted to import foreign technology as well as to enter into technological
collaborations with foreign companies.
6) Promotion of small-scale industries: Various efforts were made to increase
the importance of small-scale industries.
7) Establishment of the Foreign Investment Promotion Board (FIPB): To
further promote FDI in India, the FIPB was set up.
8) Abolition of the Monopolies and Restrictive Trade Practices (MRTP)
Act: The MRTP Act was abolished, and companies were able to freely expand
their area of operation or establish new units without licence.

 Impact of NEP/ Essence of NEP

The essence of NEP is seen in the form of liberalisation, privatisation and
globalisation.

 Liberalisation: Liberalisation refers to the removal of controls and

restrictions imposed by the government. Liberalisation in India took the
following form.
1) Abolition of licences: On the whole, the system of obtaining a licence
for the establishment of a new unit was abolished. However, the system
was retained for six industries, namely, liquor, cigarettes, defence
equipment, dangerous chemicals, industrial explosives, and drugs and
pharmaceuticals.
2) Augmentation of production: Augmentation of production implies
freedom to decide the scale and size of production as well as the price of
products. The MRTP companies (companies having assets worth more
than Rs. 100 crore) became free to expand the scale of their business
according to the market conditions.
3) Removal of trade restrictions: Restrictions regarding trade, such as
customs, duties and tariff, were removed.
4) Encouragement to foreign direct investment: Emphasis was laid on
increasing competition in the domestic market and attracting FDI.
 Privatisation: Privatisation refers to assigning a greater role to the private
sector and a gradual transfer of ownership or management of state-owned
enterprises to private sector enterprises. In India, privatisation took the
following form.
1) Disinvestment: Disinvestment implies sale of equity and strategic
sale of public sector units (PSUs) to the private sector.
2) Establishment of the Board of Industrial and Financial
Reconstruction (BIFR): The BIFR was established for the
revival of the sick and loss-making public sector enterprises.
3) Reduction in the Role of Public Sector: The number of
industries exclusively reserved for the public sector was reduced to
eight and then further to three (namely, railways, atomic mineral
and atomic energy).
4) Navratna policy: Under the Navratna policy, nine high-
performing PSUs were awarded the status of ‘Navratnas’. This
recognition encouraged these PSUs to improve their efficiency and
performance.

 Globalisation: Globalisation refers to opening up and integrating the

economy with the world economy. Globalisation in India took the
following form.
1) Removal of trade restrictions: Various trade restrictions such as
tariffs, custom duties and quotas were reduced considerably.
2) Reduction in export duty and import duty: Export duty and import
duty were reduced to promote free trade.
3) Encouragement to foreign capital investment: In accordance with
the objective of encouraging foreign capital investment, various steps, such
as increasing the equity limit of foreign capital, setting up of special
economic zones and introducing the Foreign Exchange Management Act
 (FEMA), were taken.

 Demonetisation

 On Nov 8, 2016 notes of Rs. 500 & Rs. 1,000 were ‘demonetised’- ceasing to be
legal tender
- Made 86% of money in circulation invalid
- People deposited the invalid currency in banks along with facing certain
restrictions on cash withdrawals and the convertibility of domestic money and
bank deposits.
- Aim: To curb corruption, illegal activities, unfair trade practices and
accumulation of ‘black money’

 Features
i. Measure of tax administration- black money holders had to declare the
unaccounted wealth and pay taxes at penalty rates
ii. Measure to avoid tax evasion- indicating govt. will not tolerate tax evasion
iii. Measure of channelizing savings into financial system- by depositing money in
banks
iv. Create ‘cash-less’ or ‘cash-lite’ economy- for increasing financial savings and
reducing tax evasion

 Impact of Demonetisation
i. Money/Interest Rates: Decrease in Cash Transactions, Increase in Bank Deposits &
Increase in Financial Savings
ii. Private Wealth: Decrease in Some high demonetised notes not returned
iii. Public Sector Wealth: No Effect
iv. Digitisation: Increase in Digital transactions
v. Real Estate: Decrease in Prices
vi. Tax Collection: Increase in Income tax collection
*As per Economic Survey, 2016–17
 Impact of NEP/Impact of LPG/Impact of Government Policy Changes
The following points highlight the impact of NEP on business and industry.
i. Increased competition: Policies such as abolition of the licensing policy
and dereservation increased the competition faced by domestic companies.
ii. Benefit to consumers: To survive in the environment of increased
competition, producers increasingly focussed on improving the quality of
their products. This benefited the consumers.
iii. Change in business policies: Business organisations altered their
policies and operations as per the New Industrial Policy.
iv. Technological changes: The increase in competition made firms
increasingly adopt new technology to survive in the market.
v. Need for trained personnel: The adoption of new and improved
technology by business organisations further increased their requirement
for skilled and trained personnel.
vi. Greater market orientation: To survive in the market, enterprises
increasingly paid attention to the market demand and produced goods as
per the needs and requirements of the consumers.
vii. Less reliance on budgetary support among public sector
enterprises: In order to improve efficiency and productivity, public sector
enterprises realised the need to reduce their reliance on budgetary support.