The Impact of the External Environment on Business Firms

On pp. 31-48 of Business Essentials, 5th Canadian edition, the various "environments of business" are discussed. These include the economic, technological, socio-cultural, political-legal, global, and business environments. The managers in business firms must think carefully about how these environmental factors will affect the organization they work for because these factors are complex and they present both challenges and opportunities. The following examples demonstrate the importance of the external environment.

One area that is becoming increasingly important to business firms is the political-legal environment because it presents certain risks (for example, terrorism) that must be dealt with. Lloyd's of London is a famous insurance company that is one of the world's largest underwriters of terrorism insurance. In a speech in Toronto in November 2007, a Lloyd's spokesman warned about terrorism and political risk, and said that it is not simply a threat to governments, but also to businesses. The global economy means that Canadian businesses are operating in some dangerous places and their assets are difficult to protect. In a typical year, there are 150-200 incidents of terrorism against businesses worldwide. The most at-risk businesses in Canada are hydro and nuclear plants and oil pipelines.

In the socio-cultural environment, there is increasing activity by various pressure groups who have concluded that business firms cannot be counted on to behave in a socially responsible fashion. For example, in 2007 Greenpeace—a well-known environmental pressure group—launched a media campaign against AbitibiBowater Inc., a large Canadian forest products company. As part of the campaign, it put up a banner at the company's head office that read "Looters of our Forest." In the Netherlands in October 2007, it blocked the unloading of a ship containing newsprint made by AbitibiBowater. Greenpeace has also pressured the company to adopt forest management guidelines set by the Forest Stewardship Council (FSC) rather than the Canadian Standards Association (CSA) guidelines that the company has been using. The campaign is having an effect, since FSC has more global credibility with environmental groups than CSA does.

But FSC has problems of its own. Its standards vary from one region of the world to the next, and FSC has admitted that some of the companies using its logo are not using sustainable forestry practices. Even some environmentalists are unhappy with FSC. They claim that one company in Southeast Asia that has permission to use the FSC logo has destroyed a large section of Indonesian rainforest and threatened the habitat of orangutans. After these claims were publicized, FSC rescinded the company's certification. The forestry practices of Canadian companies like AbitibiBowater—which are quite good generally—may actually be superior to those of a foreign company that is FSC-certified. These complexities and uncertainties make it difficult for managers in forestry companies to know what the optimal decision is in a given situation.

These examples demonstrate that the external environment is complicated and full of uncertainty. But that's not all. Managers must also recognize that "the environment" is not limited to just the factors in areas like the political-legal or socio-cultural environment. Another very important "environment" for many business firms is the physical environment. The most highly publicized physical environment issue at the moment is global warming. There is a consensus that global warming is occurring, but there is an intensifying debate about what is causing it. Many scientists are convinced that global warming is the result of human activity, specifically the emission of so-called "greenhouse gases," and the United Nations Intergovernmental Panel on Climate Change (IPCC) has taken the position that greenhouse gases are the cause of global warming. But many other scientists disagree, arguing that the UN is using unreliable data and is exaggerating the amount of warming that has occurred. These dissenting scientists—including editors of scientific journals, directors of centers for climate research, and professors of climatology, wildlife biology, marine geophysics, geology, mathematics, atmospheric science, computer modeling, physical geography, chemistry, and meteorology—argue that climate variability is a natural phenomenon, and that it has affected humanity throughout recorded history. They argue that we need to equip people to deal with climate change, not introduce programs to reduce greenhouse gases without good evidence that they are really the culprit. With regard to the physical environment, if managers are going to do their job effectively, they must sort out what is fact and what is opinion in the debate about the causes of global warming. This is particularly true since global warming presents both challenges and opportunities.

Challenges. Global warming presents many challenges to business firms. Consider the forestry industry. If climate predictions are accurate, B.C.'s forestry companies will be significantly affected by global warming because different species of trees thrive at different latitudes. The predicted temperature change will mean that a tree that does well today in Prince George will grow best north of the Yukon border in 80 years. Whitebark pine, for example, will almost disappear from its current range, and lodgepole pine, white spruce, sitka spruce, and western hemlock will all decrease in importance over the next 80 years. By contrast, ponderosa pine will triple, and Douglas fir and western red cedar will both increase substantially. These are dramatic changes that forestry companies will have to take into account, particularly since they have such a long planning horizon.

Global warming also means that new tree diseases will have to be dealt with. Whitebark pine, for example, can't fend off insects and fungus that exist in a warmer climate. Tree companies are now conducting tests to determine if the tree can be planted much further north to reduce the threat from insects. The most significant tree disease at the moment is the mountain pine beetle, which has killed millions of acres of trees in B.C. The warming climate has allowed the beetle population to explode, and the infestation threatens to destroy jobs, communities, and companies that are dependent on forestry. By 2013, as much as 80 percent of the lodgepole pine will be dead as a result of the beetles' boring activity. What's worse, the infestation is spreading into neighbouring Alberta.

The problems caused by the pine mountain beetle are not restricted to the forestry industry. For example, the Eagle Point golf course just outside Kamloops had to cut down 15,000 trees that were killed by the beetles. One bright spot is that tree cutting services are doing a brisk business. Eldorado Enterprises, for example, has 30 trucks and 100 employees to handle tree-cutting activities.

To complicate matters further, a dispute has erupted about how to deal with the beetle infestation. Lumber companies want to cut vast swaths of dead pine because it still has some market value. Environmentalists oppose such massive cutting, and some even argue that nothing at all should be done and that nature should be allowed to take its natural course. They accept that the pine beetle may eventually destroy 30 percent of Alberta's pine trees, but they say that's better than having logging companies cut 100 percent of them. Homeowners in areas that are infested have their own agenda. They know that if dead pine trees are not cut, an increased fire risk will develop which will threaten their homes. All of these conflicting views have created a significant challenge for companies in the forestry business.

Opportunities. Global warming may also provide opportunities for Canadian businesses. Consider the wine industry. The highest quality grapes historically have been grown in France, Spain, Australia, and California, where the climate was just right for them. But with global warming, excessive heat is beginning to be a problem in these areas. Global warming means that grapes can now be grown further and further north. In Tappen, B.C., for example, Gary Kennedy is experimenting with growing Pinot Noir grapes at a latitude where they formerly could not have survived. Grapes of this variety can survive winter temperatures down to about minus 20 degrees Celsius. Fifty years ago, it was not uncommon for temperatures to drop that low in the Okanagan Valley, but during the last decade temperatures almost never dropped that low. This has opened up a whole new geographical area for growing high-quality grapes, and the number of B.C. wineries has increased from 17 in 1990 to 136 in 2007. Wines made in this region are starting to win gold medals at European wine competitions.

The examples described above indicate that the external environment presents immense complexities, uncertainties, challenges, and opportunities for Canadian business firms. These environmental factors cannot be ignored because they have such a big potential effect on businesses. Business managers must therefore expend considerable time and energy in planning how to deal with the complexities and uncertainties, deciding how they are going to cope with the challenges, and deciding how they are going to capitalize on the opportunities that are presented by the external environment.

Questions for Discussion

1. Describe in general terms how each element of the external environment (economic, technological, socio-cultural, political-legal, global, and business) affects business firms.
2. Choose a specific industry (for example, automobile, fashion, construction, fast food, etc.) and describe how each element of the external environment is likely to affect firms in that industry.
3. Can managers in business firms control the elements in the external environment, or do they simply have to react to changes that are beyond their control? Give examples that support your conclusion.
4. Explain how the factors in Porter's Five Forces Model (rivalry among competitors, threat of potential entrants, suppliers, substitutes, and buyers) differ from the other environmental elements (economic, technological, socio-cultural, political-legal, and global).

Sources: "Don't Fight, Adapt," National Post, December 13, 2007, p. FP15; Ross McKitrick, "Contaminated Data," National Post, December 5, 2007, p. FP19; Diane Francis, "Be Very Afraid, Lloyd's Warns Us," National Post, November 29, 2007, www.nationalpost.com/story-printer.html?id=130604; Konrad Yakabuski, "Greenpeace Swinging Its Axe in the Wrong Forest," The Globe and Mail, November 15, 2007, p. B2; Tom Wright and Jim Carlton, "FSC's Green Label for Wood Product Gets Growing Pains," The Wall Street Journal, October 30, 2007, pp. B1-B2; Douglas Belkin, "Northern Vintage: Canada's Wines Rise With Mercury," The Wall Street Journal, October 15, 2007, pp. A1, A20; George Koch, "Careful With That Axe," Canadian Business, October, 2007, pp. 44-51; Nathan VanderKlippe, "Forest for the Trees," National Post, September 15, 2007, p. FP3; Barry McKenna, "Global Warming a Farmer's Bane?," The Globe and Mail, September 12, 2007, p. B3; Sean Silcoff, "Canada's Money Trees," National Post, September 8, 2007, pp. FP1, FP5; Wendy Stueck, "The Mighty Are Falling," The Globe and Mail, September 1, 2007, pp. B4-B5; Kathryn Young, "Organic Wine: It's a Money Thing," National Post, September 1, 2007, p. FP3.