It is important for managers to understand this aspect of the business environment because it can affect their firm and how it should be run. No business is insulated from the outside environment. Things like political decisions, for example, can have a huge impact on a firm by changing tax laws or regulatory regimes. As another example, the managers must be aware of things like new competitors entering their market. Clearly, managers would need to be aware of these sorts of changes.
If managers are not aware of these aspects of the environment that are external to their own firm, they may well be caught unaware and unready for changes that affect their firms.
It is important for managers to understand the external environment for five main reasons, as discussed below:
1. To understand how competition affects their business
Managers must be aware of, and understand, the competition in their business sector. This is vital because their competitors are seeking to gain market share at their expense. Likewise, managers must look for ways to increase their respective businesses' market share. Knowledge of what the competition is doing in terms of sales promotions, product mix, general pricing, customer service initiatives, and more, will help a business ensure that they have programs and policies in place to compete with their competition. Consequently, they are protecting their market share as best they can and even working to increase their market share by trying to stay one step ahead of their competition.
2. To understand how government regulations affect their business
Laws of the land affect businesses and managers must be aware of how these laws affect their operations. An example of this is the increasing environmental legislation that affect companies. To adhere to these laws and regulations, businesses must budget properly and ensure that they have knowledgeable and trained employees who can oversee the administration of these laws and regulations in the workplace. Furthermore, businesses must understand how government regulations affect their bottom line (profits) as there is always a cost to putting into place policies and procedures required to adhere to government laws and regulations.
3. To understand how technological advances affect their operations
Managers must be aware of technological innovation that can help them run their businesses more efficiently. Conversely, they must have the knowledge and courage to make a decision against succumbing to all the technological innovations out there. In essence, any technology that can reduce costs and increase production and efficiency should be seriously considered. However, changing to a new technology just because it is the "new flavor of the month", when changing will not advance their competitiveness or efficiency, or grow revenues and profits, may have to be avoided. Everything new when it comes to technology is not for every business and managers must do a "cost-benefit' analysis before putting out money for any new technology.
4. To understand how geopolitical and economic concerns can affect their business
Managers must follow the news more so than ever as worldwide turmoil, with tensions and sanctions abounding are able to directly and indirectly affect their operations. A perfect example is the Ukraine crisis and the sanctions imposed on trade with Russia. Another is the Cuba issue and some of its trade sanctions still in place. Furthermore, businesses that require capital and that are on the major markets must understand how geopolitical concerns affect investors, who may shy away from investing in a business that is at the whim of geopolitical turmoil. A current perfect example of this is the drop in oil prices and how it is affecting companies in the oil patch. Many are suspending new exploration and laying off staff until oil prices rebound and stabilize. Some investors are shying away from investing in the oil patch presently.
5. To understand the labor force
Managers must understand what skilled labor is available to help them run their businesses properly. They must know what their competition is willing to pay qualified personnel, and they must be ready to do the same so they can attract first-rate candidates to their enterprises. Managers must be aware of college and university programs that are training suitable candidates to populate their businesses. They must aggressively recruit from these colleges and universities or else their competitors will beat them to the punch and have an edge when it comes to knowledgeable and business savvy employees.