Why is it important for a firm to study and understand the external environment?

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It is important for a firm to study and understand the external environment because that environment can determine what strategies the company will need to pursue in the future.  Let us look at the example of an oil/gas company in the United States right now.  It must understand:

  • The political environment, in which a Romney victory might lead to fewer restrictions on drilling.  An Obama victory might be seen as a political risk because of the possibility of tightened regulations.
  • The social environment.  The firm has to understand how (or if) consumers' attitudes towards oil and energy consumption are changing.
  • The technological envrionment.  Firms have to be up on the latest in "fracking" technology so they do not get left behind.

These are examples of aspects of the external environment that could affect a business's prospects.  If a firm does not study and understand these things, it could get caught by surprise, leading to a loss of profit.

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