External environment illustration External environment theory

How businesses are affected by government policy

Governments create the rules and frameworks in which businesses are able to compete against each other. From time to time the government will change these rules and frameworks forcing businesses to change the way they operate. Business is thus keenly affected by government policy. Key areas of government policy that affect business are:

Economic policy

A key area of government economic policy is the role that the government gives to the state in the economy. Between 1945 and 1979 the government increasingly interfered in the economy by creating state run industries which usually took the form of public corporations. However, from 1979 onwards we saw an era of privatisation in which industries were sold off to private shareholders to create a more competitive business environment.

Taxation policy affects business costs. For example, a rise in corporation tax (on business profits) has the same effect as an increase in costs. Businesses can pass some of this tax on to consumers in higher prices, but it will also affect the bottom line. Other business taxes are environmental taxes (e.g. landfill tax), and VAT (value added tax). VAT is actually passed down the line to the final consumer but the administration of the VAT system is a cost for business.

Another area of economic policy relates to interest rates. In this country the level of interest rates is determined by a government appointed group - the Monetary Policy Committee which meets every month. A rise in interest rates raises the costs to business of borrowing money, and also causes consumers to reduce expenditure (leading to a fall in business sales).

Government spending policy also affects business. For example, if the government spends more on schools, this will increase the income of businesses that supply schools with books, equipment etc.

Government also provides subsidies for some business activity - e.g. an employment subsidy to take on the long-term unemployed.

Legal changes

The government of the day regularly changes laws in line with its political policies. As a result businesses are continually having to respond to changes in the legal framework.

Examples of legal changes include:

i. The creation of a National Minimum Wage which has recently been extended to under-18's.

ii. The requirement for businesses to cater for disabled people, by building ramps into offices, shops etc.

iii. Providing increasingly tighter protection for consumers to protect them against unscrupulous business practice.

iv. Creating tighter rules on what constitutes fair competition between businesses.

Today British business is increasingly affected by European Union (EU) regulations and directives as well as national laws and requirements.

Supporting Documents

These downloads will help to put external-environment theory into context using real world examples from real businesses.

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Discover how McCain Foods employed external-environment theory to thrive in the food & drink industry by downloading our premium case study.

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