Seeing the Bigger Picture: The Importance of Understanding Your External Environment

What makes up an industry’s external environment?

In the ever-changing business landscape, no industry is an island. No matter how you choose to manage and operate your business, external forces shape the industry you operate in and can contribute to the success or failure of any business.

While internal forces are elements within your control, like the structure of your organization, your workplace culture or financial resources, the external factors are not forces you can easily influence. Broadly speaking, the external environment includes political, legal, social, economic, technological, environmental and demographic factors. It’s a bit of a whirlwind, with different pressures pushing on an industry from all sides—and your business is at the center of it all.

Understanding the nuances of your industry's external environment is crucial, regardless of whether you’re an ambitious entrepreneur launching a startup, a seasoned business leader or a prospective business partner. Knowing what forces are at play helps you understand customer demands and prevailing market conditions, and shapes strategic planning, funding and operational considerations.

• External Drivers
• Regulation and policy
• Industry assistance

Let’s unpack these influences.

What are external drivers?

Within an industry's external environment, individual external drivers exert varying degrees of influence. These drivers encompass a whole host of factors that are outside industry players’ control but directly affect performance and operations.

When we think of external drivers, major global events like conflicts, pandemics and inflation readily come to mind. However, we can’t ignore the less attention-grabbing influences, such as production costs, exchange rates and consumer confidence patterns. Understanding these factors helps you build resilient business strategies, make more informed decisions, and analyze and mitigate risk.

An industry’s external drivers typically fall into two categories; macroeconomic and demographic.

Macroeconomic External Drivers

Macroeconomic drivers are the wider economic conditions and trends that influence industries and their performance. These factors include GDP growth, inflation, unemployment, interest rates, fiscal and monetary policies, and global economic trends. Shifts in macroeconomic drivers tend to have wide-reaching impacts across multiple sectors, rather than influencing a single industry.

Demographic External Drivers

Demographic drivers capture the characteristics, behaviors and trends of a population. These drivers include population size and distribution; income levels; labor force dynamics; consumption patterns; technology use; and cultural and ethnic diversity. Demographic drivers change more slowly over time than macroeconomic drivers, but they significantly impact industries by shaping demand, consumer preferences and workforce dynamics. These drivers are therefore crucial to a business’s inputs and ability to earn income, and can be key indicators of an industry’s longevity and risk.

How do regulation and policy affect industries?

Regulation and policy play a crucial role in shaping industries, as they provide a framework for businesses to operate within. Governments implement regulations and policies to achieve economic and social objectives, and these measures can have significant flow-on effects for businesses.

In any industry, businesses must comply with relevant regulations, even if they are stringent, costly or restrict growth. While high levels of regulation may seem like a burden, they often aim to create a level playing field for businesses and prevent unfair advantages. Crucially, regulation helps reduce harm, exploitation and negative impacts on communities, industries and the environment, and encourages businesses to operate responsibly.

Different industries face varying degrees of regulation and policy influence. Industries in sectors like recreation and entertainment typically encounter lower levels of regulation than sectors like mining, which have an outsized impact on the environment, or gambling, which poses greater risks to individuals and communities.

Complying with regulations and policies is not without its challenges, especially for businesses in highly regulated sectors, or those where regulations are changing quickly. Compliance costs, administrative requirements and the need to adapt to evolving regulations can present obstacles to growth. However, businesses must recognize that regulations serve a broader purpose in safeguarding societal interests and maintaining industry standards.

What is industry assistance?

Assistance refers to the support, guidance and resources that industries receive from entities outside their immediate sphere of influence. These entities can include government agencies, non-profit organizations, academic institutions, research centers and even individual experts. The assistance they provide ranges from funding and mentorship to research collaboration and policy formulation, often with the following goals in mind:

1. Accelerating innovation and research by providing additional funding for technology or bringing fresh perspectives, cutting-edge technologies and novel ideas to industries through collaborations with research institutions and academia.
2. Bridging the funding gap by providing access to capital through government grants, venture capital investments and angel funding, which allows businesses to scale operations and transform ideas into realities.
3. Navigating Regulatory Landscapes by providing guidance from specialized legal and consulting firms, industry associations, and chambers of commerce, reducing legal complexities and supporting a favorable business environment.
4. Fostering Collaboration and Networking by bringing stakeholders together through industry-specific conferences, workshops and trade shows and creating opportunities for strategic alliances, joint ventures and market expansion.

How does the external environment affect industries?

It’s helpful to unpack an example to properly understand how these forces affect industries. Let’s take a look at the similarities and differences in the external environments that shape the public healthcare sectors in Australia, the US and Europe.

External drivers for healthcare sectors

Australia, the US, and Europe all face demographic challenges that shape healthcare demands. Australia and the US share an aging population, which increases demand for aged care and chronic disease management services. Europe also grapples with an aging population, coupled with shifting disease prevalence and diverse healthcare needs due to immigration and cultural diversity.

In Australia, income inequality and regional disparities impact healthcare services, particularly in remote and rural areas. The US faces significant socioeconomic disparities, which causes unequal access to healthcare and high costs. Conversely, many European countries prioritize equitable access and work to reduce socioeconomic disparities through healthcare policies and considering social determinants of health.

These similarities and differences in external drivers mean that, while they operate in the same industries, businesses from each region must employ different strategies to be successful. While an ageing population means that successful businesses from each region will likely target services towards the elderly (such as aged care, retirement communities and assisted-living services), differences in other drivers shape how businesses implement that strategy.

Australian healthcare businesses tend to shy away from serving populations in remote and rural areas due to limited infrastructure and workforce distribution. For-profit US healthcare providers and pharmaceutical companies may have opportunities to cater to wealthier people, while businesses serving low-income individuals often face challenges due to limited access to healthcare services. European countries' focus on equitable access to healthcare creates opportunities for businesses to cater to diverse socioeconomic groups. Companies offering affordable healthcare solutions, medical technologies, and services targeting vulnerable populations have a higher chance of success in many European countries than in other regions.

Assistance for healthcare sectors

Government support varies between the US, Australia and Europe. Australia's publicly funded healthcare system, Medicare, ensures access to essential services for all citizens, offering a stable environment for businesses. Government subsidies and funding programs bolster the public healthcare sector, allowing businesses to expand their services and develop innovative solutions. Businesses whose operations align with government priorities, such as primary healthcare and preventive care, can often access additional funding opportunities and partnerships.

In the US, government support primarily targets specific populations through programs like Medicaid and Medicare. However, private health insurance holds significant sway over healthcare access and reimbursement rates. This unique mixed system poses challenges for businesses, as they navigate complex reimbursement processes, negotiate contracts with private insurers, and adapt to variations in payment rates and coverage. Depending on private insurance creates complexities that impact the financial stability and shape operational strategies of businesses in the public healthcare sector.

In contrast, many European countries embrace comprehensive government support through universal healthcare systems. These systems are typically funded by social health insurance and taxation, ensuring a consistent revenue stream for businesses. For businesses operating within Europe's public healthcare sector, such as UK hospitals, this support creates a stable and predictable market. With all citizens having access to healthcare services, businesses can focus on service quality, innovation, and long-term planning. The broader customer base minimizes the financial risks associated with serving specific populations, enabling businesses to thrive.

Regulation and policy in healthcare sectors

The regulatory environment in Australia ensures compliance, safety, and quality standards for businesses in the public healthcare sector. Companies must adhere to licensing requirements, accreditation processes, and regulations governing healthcare facilities, medical devices, and pharmaceuticals. This creates a standardized framework that promotes patient safety and quality of care. However, regulatory compliance can impose administrative burdens and additional costs on businesses.

The US healthcare sector exists within a complex regulatory landscape, with businesses needing to account for both federal and state-level regulations. These regulations come from federal agencies such as the Food and Drug Administration (FDA) and Centers for Medicare and Medicaid Services (CMS), and from health departments at the state level. The regulatory environment shapes various aspects of business operations, including product approvals, clinical trials, reimbursement policies, and compliance with privacy and security regulations such as HIPAA. The diverse and evolving regulatory requirements can present challenges for businesses, including high compliance costs, administrative burdens, and delays in product approvals.

European countries have robust healthcare regulation frameworks that ensure patient safety, high quality standards and equitable access to healthcare services. Companies operating in the public healthcare sector must adhere to regulations related to product approvals, clinical trials, advertising and marketing, and data protection. The European Medicines Agency (EMA) plays a crucial role in regulating pharmaceuticals across the European Union. While navigating the regulatory process can be rigorous, having a harmonized regulatory framework across European countries can provide businesses with a streamlined approach to market entry and expansion.

Healthcare summary

To boil it all down, demographic factors, socioeconomic disparities, government support and policies, and the regulatory environment all shape the operating environments for businesses within the public healthcare sector in Australia, the US and Europe. Understanding the unique impacts of these external factors is crucial for businesses to identify opportunities, manage risk, and develop strategies tailored to each region's specific dynamics. Aligning with demographic trends, government priorities, and regulatory requirements allows businesses to position themselves for growth and success within their respective industries.

What do you risk by ignoring your external environment?

If you turn a blind eye to your industry's external environment, you're not just risking general oversight or legal trouble - you could also be missing out on significant opportunities. The risks of failing to understand your industry’s external environment include:

1. Being blindsided: Unexpected elements in your industry's external environment can catch you off guard and disrupt your business. IBISWorld quantifies a sensitivity risk score for each industry to measure how susceptible the industry is to changes in external factors, which you can use to quantify non-financial risks. By staying informed, you can avoid being blindsided by changes that shape the operating conditions of your industry, empowering you to make smart business decisions.
2. Falling behind competitors: Neglecting to understand the external environment puts you at a disadvantage compared to your savvier competitors. Without dedicating time and effort to grasp the dynamics of your industry's external landscape, you risk falling behind in terms of innovation, customer satisfaction, and market position. Keeping pace with industry trends and emerging developments allows you to stay competitive, retain existing business, and maintain cashflow.
3. Missing opportunities: Being unaware of your external environment can mean that you miss opportunities to grow your business or make strategic decisions that don’t maximize your potential. Ignoring your external environment could see you steer your business in the wrong direction because you’re not keeping up with outside influences impacting your industry.

What can you gain by understanding your industry’s external environment?

Anyone in the business world can tell you there’s a lot at stake, and the wrong decisions can quickly have serious consequences. Thankfully, it’s not all bad news. Equipping yourself with a solid understanding of your industry’s external environment empowers you to make better business decisions and lead your company to greater success.

Analyzing your industry’s external environment has countless real-world business applications. This knowledge is crucial for conducting a thorough competitive analysis with a framework like Porter’s Five Forces or PESTLE, and empowers you to evaluate how your responses to forces outside your control measure up against other players in your industry. Analyzing and responding to external factors like regulations, demographic trends and wider macroeconomic considerations in an industry’s external environment is also a key component of a successful product development.

If you’re looking for helpful insights into the industry in which your business operates – and, let’s face it, every decision maker is – you can learn more about the external drivers, assistance, and regulation and policy factors at play in our Industry Research Reports. These insights equip you with the industry expertise to prepare your business for any changes that could impact operations and take crucial steps towards long-term success and sustainability.

As part of our commitment to providing unrivaled industry research, we’re consolidating data and analysis on external factors into one new chapter. To stay up to date on the latest industry insights and the enhancements we’re rolling out as part of the Modern Research Experience, subscribe to Insider Monthly or follow IBISWorld on LinkedIn.