Macro Environment Analyses

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Chapter 2: External Analysis: The Identification of Opportunities and Threats: 2-7a Macroeconomic Forces Book Title: Strategic Management: An Integrated Approach: Theory and Cases Printed By: Pearl Chen ([email protected]) © 2020 Cengage Learning, Inc.

2-7a Macroeconomic Forces

Macroeconomic forces affect the general health and well-being of a nation and the regional economy of an organization, which in turn affect companies’ and industries’ ability to earn an adequate rate of return. The four primary macroeconomic forces are the growth rate of the economy, interest rates, currency exchange rates, and inflation (or deflation) rates. Economic growth, because it leads to an expansion in customer expenditures, tends to ease competitive pressures within an industry. This gives companies the opportunity to expand their operations and earn higher profits. Because economic decline (a recession) leads to a reduction in customer expenditures, it increases competitive pressures. Economic decline frequently causes price wars in mature industries.

Interest rates can determine the demand for a company’s products and thus are important whenever customers routinely borrow money to finance their purchase of these products. The most obvious example is the housing market, where mortgage rates directly affect demand. Interest rates also have an impact on the sale of autos, appliances, and capital equipment, to give just a few examples. For companies in such industries, rising interest rates are a threat and falling rates an opportunity. Interest rates are also important because they influence a company’s cost of capital, and therefore its ability to raise funds and invest in new assets. The lower the interest rate, the lower the cost of capital for companies and the more potential investment.

Currency exchange rates define the comparative value of different national currencies. Movement in currency exchange rates has a direct impact on the competitiveness of a company’s products in the global marketplace. For example, when the value of the dollar is low compared to the value of other currencies, products made in the United States are relatively inexpensive, and products made overseas are relatively expensive. A low or declining dollar reduces the threat from foreign competitors while creating opportunities for increased sales overseas. The fall in the value of the dollar against several major currencies during 2004–2008 helped to make the U.S. steel industry more competitive, whereas its rise during 2012–2014 made the industry less competitive.

Price inflation can destabilize the economy, producing slower economic growth, higher interest rates, and volatile currency movements. If inflation continues to increase, investment planning becomes hazardous. The key characteristic of inflation is that it makes the future less predictable. In an inflationary environment, it may be impossible to predict with any accuracy the real value of returns that can be earned from a project 5 years down the road. Such uncertainty makes companies less willing to invest, which in turn depresses economic activity and ultimately pushes the economy into a recession. Thus, high inflation is a threat to companies.

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Price deflation also has a destabilizing effect on economic activity. If prices fall, the real price of fixed payments rises. This is damaging for companies and individuals with a high level of debt who must make regular, fixed payments on that debt. In a deflationary environment, the increase in the real value of debt consumes more household and corporate cash flows, leaving less for other purchases and depressing the overall level of economic activity. Although significant deflation has not been seen since the 1930s, in the 1990s it took hold in Japan; in 2008–2009, concerns grew that it might re-emerge in the United States as the country plunged into a deep recession (and although that did not occur, inflation remained muted).

Chapter 2: External Analysis: The Identification of Opportunities and Threats: 2-7a Macroeconomic Forces Book Title: Strategic Management: An Integrated Approach: Theory and Cases Printed By: Pearl Chen ([email protected]) © 2020 Cengage Learning, Inc.

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