What is an Economic Environment?
An economic environment refers to many factors that have an impact in the market because they can influence commercial and consumer behaviors. These factors are external to companies and hence hard or impossible to control. But companies need to evaluate the conditions and use it as part of their decision-making process. The economic environment a company operates in will impact how the business develops and what performance they will have. The factors can appear to be opportunities or threats to the company and it is their responsibility to identify the changes and design action plans to address those changes.
The factors can be part of microeconomics or macroeconomics. Microeconomic factors are things that happen within an individual company or industry and do not affect the whole economy. Some examples are competitors, demand, suppliers, and distribution chain. Macroeconomic factors are things that affect the entire economy as they are more generic and within a larger scale. Some examples are unemployment, inflation, and interest rates.
It is also important to stress that sometimes the economic factors are perceptions of the consumer. Because of this, a company needs to not only understand the real factors in the economic environment, but also understand the perception of their customer towards the environment.
Economic environment studies future economic conditions, current economic conditions or conditions of the recent past. The priority lays in understanding the leading indicators within your economy and what economic reactions may yield in the immediate future (three to six months).
Examples of Economic Indicators
Let’s review some economic indicators and what the impacts can be in a business setting.
The income of the customers will define their ability to spend money on the products offered in the market. This is often referred to as purchasing power. As income fluctuates for a customer, the decisions made on what to purchase and how much to purchase might change. If the customer receives a raise, they might be willing to switch to a premium brand. If the customer suffers a pay cut, they might decide to buy less amount than they used to until they have more money. Unemployment is another economic factor and it acts like income. It can sometimes have a bigger impact as often the customer doesn’t know how long the unemployment will last for and might make more drastic adjustments to its purchasing behaviors. Business can only succeed if the demand for the products they are manufacturing remains steady.
It is also important to understand the culture of the countries a company is selling products too. There are emerging markets that have a saving rather than spending mentality. If a customer is concentrated in saving, even though there is purchasing power and income to purchase, there is no guarantee that the buyer will purchase.
Inflation is an increase in prices dictated by the market. The increase can come from material suppliers and or finished products. For products and services which sales fluctuate based on pricing, also known as price elastic, they will get impacted when a period of inflation generates. Businesses are constantly working to become more efficient and generate savings to fight inflation and hence maintain or raise their levels of volume.
It is believed that crude oil price is the dictating factor of the stability or instability of the economy. Many different factors are linked into the increase or decrease of the price of crude oil. It is often the first step in major movements of all commodities and exchange rates.
It is important to understand exchange rates for any business that imports, exports or has business arrangements with other countries of different currency. This economic factor has become more important through time as supply chains become more global in nature. For a company that exports, it is more profitable to do so when the currency of the country exporting to is weaker. For a company that imports, they can lose money if they are importing from countries whose currency is higher. So businesses would want to balance these differences by exporting to countries with strong currency and importing from countries with weak currency, as long as the business rules allow it. The company might also decide to manufacture the products in countries with lower labor costs, as long as they have a plan for currency appreciation. A business should also consider diversifying locations just as an individual should diversify the investing portfolio.