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 Handy BUSS4.2 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

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 3

Business Cycle The 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: Trend rate of economic growth Real GDP Boom Recovery Slump Recession BUSS4.2 Economic Environment Time 4

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 5

Business Cycle – Boom Business 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 6

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 The worst recession in the UK since 1979 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. 1979 saw the start of Britain’s decline into a recession – mirrored in the music of the day Ghost Town The Specials BUSS4.2 Economic Environment 7

Business Cycle – Recession Business 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 8

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 9

Business Cycle – Slump Business 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 10

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 11

Business Cycle – Recovery Business 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 12

Evaluating strategies that businesses might deploy in response to changes in the business cycle Recovery/Boom Increase 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 13

Evaluating strategies that businesses might deploy in response to changes in the business cycle Recession/Slump Cut 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 14

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 BUSS4.2 Economic Environment 15

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 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 and means 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 17

Economic variables - Inflation What is it? A general rise in prices or a fall in the value of money There 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 costs Explain the relationship between inflation, pay and cost of living. What happens to inflation in a recession? BUSS4.2 Economic Environment 18

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 19

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 20

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 21

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 22

Globalisation of markets Remember, questions should be answered about the impact on the firm NOT the impact on the UK economy 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 BUSS4.2 Economic Environment 23

Globalisation of markets Benefits 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 24

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 HSBC The world’s local bank. Can Global localisation be a strength of a business? Are business leaders in France right to fear globalisation? BUSS4.2 Economic Environment 25

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 26

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 Star High Market Growth High Market Share BUSS4.2 Economic Environment 27

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 BUSS4.2 Economic Environment 28

ACTIVITY – Economic Environment Terminology 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. 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. 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 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. BUSS4.2 Economic Environment

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