Why Is It Important to Consider External Factors in Your Business Plan?

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As a business owner, some things are under your control, such as who you hire and what products you sell. External factors are the things outside your control, such as the economy, your competition, your customers and other elements in your external environment. Your business plan needs to consider how external factors can affect your company for better or worse. Never forget the importance of environmental factors in business.

Writing a Business Plan

Your business plan turns dreams about the future of your company into specific written goals and projections. A good plan tackles the big questions, such as how long it will take your company to turn a profit, how many employees you'll need and how much control you're willing to yield to investors. Writing everything down forces you to think through your answers and make firm decisions.

External factors lie outside your decision-making authority. You can't stop your competitors from offering a better product or keep the economy from sinking into recession. Your business plan can, however, take external factors into account. For instance, if you know your top competitor is going on a hiring binge, that will affect how you plan to recruit and reward employees.

Internal and External Analysis

You can't write a good business plan based on guesses. To get the hard facts that you need requires internal and external analysis. Internal analysis looks at your company's strengths and weaknesses, such as the uniqueness of your product (a strength) and a lack of financing (a weakness). External analysis looks at the outside factors that can affect your success.

  • Technology: The classic example is the internet, which changed how business around the world is performed.

  • Social Factors: The growing senior population in the United States is interested in products it wouldn't have cared about at 25.

  • Law: New laws about pollution or sexual harassment can have a huge impact on your business.

  • Economics: If you do a lot of business overseas, changes to tariffs or exchange rates will affect your bottom line.

  • Politics: The United States government imposes many regulations on business, and so do state and local governments.

  • Direct Competitors: A good business plan has to consider your rivals and the products and services they offer.

  • Prospects: Prospects are potential buyers who don't do business with you yet. In your business plan, you can work out how to turn them into customers.

While there are many external factors that can affect your business, you can identify the core ones with the acronym PESTLE, for political, economic, social, technological, legal and environmental factors.

SWOT is another way to group your analyses. It breaks all factors, internal and external, into four classes: strengths, weaknesses, opportunities and threats. Your company's strengths and weaknesses are internal factors. Your opportunities and threats are external.

The Importance of External Analysis

Your business plan has to deal with the importance of external environments in managing organizations. To make the business plan effective, you need detailed information about how the external environment affects you. If, say, you're making an external analysis of your direct competitors, you might want the following information:

  • Where is your competitor located?
  • What are their annual sales?
  • Who are the major managers and board members?
  • Is the company owned by another corporation?
  • What is the company's product line?
  • What are its strengths?
  • What are its weaknesses?
  • How do the company's products compare to yours? The standards can include ease of use, appearance or other criteria of your choice.
  • How do they price their products?
  • What are their marketing activities?
  • Who are their suppliers?
  • Are they expanding or cutting back?
  • What are the strengths and weakness of their marketing and sales literature?

You can find this sort of information by reading annual reports, press releases, presentations to investors and articles about the company. The results of your external analysis tell you how to compete effectively. They also help you anticipate how the competition might react to your company's new product or pricing strategy.

Matching External and Internal

External analysis isn't the end game. It's just one step toward drawing up a good plan. Internal and external factors don't exist in a vacuum. For instance, suppose you see an opportunity for a new product line, but you don't have the ability to create one. The opportunity is external, and the limits on your ability to exploit it are internal.

To see how internal and external factors affect each other, make a grid with four squares:

  • Strengths interacting with opportunities
  • Weaknesses and opportunities
  • Strengths and threats
  • Weaknesses and threats

This is known as a TOWS grid. You can use the four squares to see how well equipped you are to handle the threats and take advantage of the opportunities:

  • Strength/Opportunity: Here you look at ways you can exploit opportunities. If your strengths include a top sales force, for example, they may be able to easily introduce a new technology or product line to established customers.

  • Strength/Threat: This looks at your ability to overcome external problems. If you make gas-guzzling cars, for example, a rise in fuel prices is an external threat. If your strengths include a good engineering department, you may be able to market a new line with fuel-efficient engines.

  • Weakness/Opportunity: Here you look at opportunities that you might miss because of your internal weaknesses. If you have no experience selling outside rural areas, that's a weakness. If you get an opportunity to expand into major metropolitan markets, you need a strategy to overcome your weakness. For example, you could hire away experienced sales pros from your competition.

  • Weakness/Threat: If you have everything riding on one successful product, that's a potential weakness. Competition from bigger firms with larger marketing budgets and lower production costs is a potential threat. A good business plan will come up with counter moves, such as broadening your product line.

A TOWS grid doesn't automatically suggest strategies. It does show you where you need to develop strategies to defeat threats and rise to opportunities. You may find the solution to a given challenge is eliminating a weakness or building on one of your strengths.

It may be that your weakness makes you too vulnerable to cope with a threat, or your strengths simply aren't strong enough. In that case, you may have to turn to outside help, partnering with other businesses or inviting in new investors.

Writing the Plan

Once you've analyzed the effect of external factors and worked out how you'll respond to them, you incorporate that material into your business plan. How you write the plan depends partly on the purpose for which you intend to use it.

If you want to attract investors or lenders, a business plan shows them why they should trust you with their money. Craft the plan to emphasize your company's potential and your ability to overcome external threats. It includes your sales and marketing strategy and your projected profits. As you'll be showing it to people who know nothing about you or your business, you'll have to make it clear, concise and compelling.

Some business plans are written for internal use, not external use. The goal is to give you a clear map for planning the future and avoiding bumps in the road. You can share it with key employees so they too understand where the company is going. This version still needs the insight from your external analysis.

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About the Author

Fraser Sherman has written about every aspect of business: how to start one, how to keep one in the black, the best business structure, the details of financial statements. He's also run a couple of small businesses of his own. He lives in Durham NC with his awesome wife and two wonderful dogs. His website is frasersherman.com