Understanding Competitive Forces, Political/Legal Factors, and Economic Influences
Competitive Environment: Porter's Five Forces
Overview of Porter's Five Forces Framework
Porter's Five Forces is a strategic framework developed by Professor Michael Porter of Harvard Business School in 1979. It analyses competitive intensity and industry attractiveness by examining five forces that shape competition and determine profitability.
The Five Forces:
Industry Rivalry - Competition intensity among existing firms
Threat of New Entrants - How easy it is for new competitors to enter
Bargaining Power of Buyers - Customer influence over businesses
Bargaining Power of Suppliers - Supplier influence over businesses
Threat of Substitutes - Alternative products/services meeting same needs
Key Principle: Industry profitability is determined by the collective strength of all five forces. Industries where all forces are weak tend to be highly profitable (firms can maintain high prices and margins). Industries with strong forces have low profitability (competitive pressures squeeze margins).
Strategic Value: Understanding these forces helps businesses: assess industry attractiveness, identify opportunities to improve competitive position, anticipate changes in competition, and develop strategies to influence forces favorably.
1. Industry Rivalry (Competitive Rivalry)
Theory
Definition: Industry rivalry examines competition intensity among existing firms. High rivalry leads to price wars, increased marketing spend, and margin pressure.
Why It Matters: Intense rivalry directly erodes profitability by forcing businesses to reduce prices or increase costs (marketing, innovation, service) without corresponding revenue increases. When rivalry is high, profits are squeezed in zero-sum battles where one firm's gain comes at another's expense.
Factors That INCREASE Rivalry:
Many similar-sized competitors: When numerous firms of equal size compete, no single firm can dominate. Each has incentive and ability to challenge others for market share. Example: UK supermarkets with Tesco, Sainsbury's, Asda, Morrisons, Aldi, Lidl all competing.
Slow industry growth (0-2% annually): When markets stagnate, firms can only grow by taking competitors' customers. This creates zero-sum competition intensifying rivalry. Rapid growth (5%+ annually) reduces rivalry as all firms can expand simultaneously.
Low product differentiation: Commoditized products force price competition as customers see no quality difference. When products are identical (petrol, basic groceries), price becomes main competitive factor. High differentiation (Apple's ecosystem, luxury brands) reduces rivalry as firms compete on features/quality rather than price alone.
High fixed costs: Industries with substantial fixed investments (factories, stores, aircraft) create pressure to maintain high capacity utilization. Fixed costs must be paid regardless of volume, so firms cut prices to maintain sales rather than accept idle capacity. Airlines exemplify this - enormous fixed costs lead to aggressive pricing to fill seats.
High exit barriers: When leaving is difficult/expensive (specialized assets, long-term commitments, emotional attachment, government restrictions), firms remain even when unprofitable, intensifying rivalry. Firms stay hoping conditions improve, creating overcapacity and price wars.
Diverse competitors: Firms with different objectives, origins, or strategies compete unpredictably. Foreign entrants seeking market share, startups pursuing growth over profits, and established firms protecting margins adopt different tactics, creating instability and intensified competition.
Real Business Example: UK Supermarket Industry
Context: UK grocery retail demonstrates intense rivalry among Tesco (27% share), Sainsbury's (15%), Asda (13%), Morrisons (10%), Aldi (10%), and Lidl (7%).
Evidence of High Rivalry:
Price wars: Tesco's "Aldi Price Match" and Sainsbury's matching schemes cost billions annually. Margins compressed from 5-6% to 2-3% industry-wide.
Loyalty investment: Tesco spends £500m annually on Clubcard rewards (10m users); Sainsbury's Nectar has 19m members.
Store closures: Tesco closed 76 stores (2015-2021); Sainsbury's 125 convenience stores - evidence of unsustainable competitive positions.
Online investment race: £10+ billion sector-wide in digital infrastructure, further pressuring margins.
Marketing: Shift to price promotion from brand advertising
HR: 30,000+ job losses sector-wide through automation
2. Threat of New Entrants
Theory
Definition: Entry barriers determine how easy/difficult for new competitors to enter. High barriers protect incumbent profitability; low barriers mean new competitors can easily enter, increasing competitive intensity.
Why It Matters: Even attractive current profits will attract new entrants unless barriers prevent entry. Sustainable profitability requires not just current good conditions but also barriers preventing new competition from eroding those conditions.
Major Barriers to Entry:
Capital Requirements: Large upfront investments deter entry. Starting pharmaceutical company requires £100m+; commercial aircraft manufacturer £10bn+; consulting business £50k. Higher requirements = fewer potential entrants.
Economies of Scale: When incumbents have cost advantages from large volumes, entrants face dilemma: enter at large scale (massive investment/risk) or accept cost disadvantages. Supermarkets benefit from scale in purchasing, distribution, marketing.
Brand Loyalty & Switching Costs: Established brands benefit from familiarity and trust. Overcoming requires massive marketing investment. High switching costs (learning new systems, data migration, compatibility loss) make customers reluctant to try alternatives.
Access to Distribution: If incumbents control distribution (shelf space, sales relationships, digital platforms), entrants struggle to reach customers. Retailers favor established brands with proven sales.
Government Regulation: Licensing, patents, regulatory approvals create absolute barriers. Banking requires FCA authorization; pharmaceuticals need MHRA approval after years of clinical trials; patents grant 20-year monopolies.
Cost Advantages Independent of Scale: Proprietary technology, favorable raw material access, prime locations, experience curve effects, or cumulative investment provide advantages money alone cannot rapidly buy.
Expertise: GSK employs 15,000 in R&D; decades of accumulated knowledge
Result: No genuinely new pharmaceutical companies in decades. Even AstraZeneca's COVID vaccine required £65m government funding and Oxford partnership.
Example: UK Digital Banking (LOWER Barriers)
Barriers Reduced By:
Technology: Cloud computing reduced costs from £billions (branch networks + IT) to £tens of millions (digital-only)
Regulation: FCA streamlined licensing (12-18 months vs 3-5 years previously)
Customer behavior: 60% of millennials willing to try digital-only banks
No branches needed: Eliminates £1-5bn branch network costs
Definition: Buyer power examines customer influence over businesses. Powerful buyers force prices down, demand higher quality, and play competitors against each other at suppliers' expense.
Factors Increasing Buyer Power:
Concentrated buyers: Few large customers have more power than many small ones
High purchase volumes: Bulk buying power enables better terms
Low switching costs: Easy to change suppliers increases buyer leverage
Many alternatives: Multiple substitute products increase negotiating power
Price sensitivity: When products represent significant cost, buyers negotiate aggressively
Low differentiation: Commodity products give buyers more power
Example: UK Automotive Components (HIGH Buyer Power)
Suppliers to JLR face extreme buyer power:
Concentrated buyer: JLR is single customer (300,000 vehicles annually)
Quality requirements: Zero-defect with £50,000/hour penalties for stoppages
JIT delivery: 2-4 hour windows; suppliers hold inventory and bear costs
Payment terms: 60-90 days creates working capital pressure
Result: Suppliers operate on 3-5% margins; many forced to consolidate or exit.
4. Bargaining Power of Suppliers
Theory
Definition: Supplier power assesses influence that input suppliers have over businesses. Powerful suppliers raise prices, reduce quality, or limit supply, capturing value from buyers.
Factors Increasing Supplier Power:
Few suppliers: Limited alternatives increase supplier leverage
Unique products: Specialized inputs with no substitutes
High switching costs: Expensive/difficult to change suppliers
Critical inputs: Essential components give suppliers leverage
Forward integration threat: Suppliers could compete directly
Example: Airlines vs Aircraft Manufacturers (HIGH Supplier Power)
British Airways faces duopoly:
Only 2 suppliers: Boeing and Airbus dominate large aircraft (99%+ share)
Switching costs: £100m+ for retraining, facilities, spare parts
Long lead times: 5-10 years from order to delivery
Price power: 3-5% annual increases regardless of demand
Payment terms: Airlines pay 60-70% before delivery
Result: Airlines have virtually no negotiating leverage; must accept manufacturer terms.
5. Threat of Substitutes
Theory
Definition: Substitutes are alternative products/services meeting same needs through different means. They limit prices and profits by providing customers with alternatives.
Factors Increasing Substitute Threat:
Better price-performance: Substitutes offering more value
Low switching costs: Easy to try alternatives
High quality: Substitutes match/exceed current offerings
Low differentiation: Products meet similar needs
Example: Black Cabs vs Uber (HIGH Substitute Threat)
Impact: Black cab drivers fell 25% (2012-2019). Traditional response: own apps (Gett), lobbying for regulation, emphasizing driver knowledge.
Test Your Understanding: Competitive Environment Quiz
Question 1: Which factor INCREASES competitive rivalry?
Question 2: Why do UK pharmaceuticals face HIGH entry barriers?
Question 3: Which shows HIGH buyer power?
Question 4: Why do airlines face HIGH supplier power?
Question 5: Why was Uber a HIGH substitute threat to black cabs?
Political and Legal Environment
Overview
The political and legal environment encompasses government policies, legislation, and regulatory frameworks that directly impact business operations. Changes create both opportunities and threats across all functional areas.
Environmental Protection - Regulations on pollution, emissions, sustainability
Strategic Importance: Unlike competitive forces which businesses can sometimes influence, political/legal factors are largely external constraints businesses must navigate. However, businesses can engage in lobbying, industry advocacy, and strategic planning to minimize negative impacts and capitalize on opportunities.
1. Trade Agreements
Theory
Definition: Trade agreements are treaties between countries determining tariffs, quotas, standards, and market access. They significantly impact businesses engaged in international trade.
Types of Trade Agreements:
Free Trade Agreements (FTAs): Eliminate or reduce tariffs between signatory nations while allowing independent trade policies with non-members. Example: UK-Japan Comprehensive Economic Partnership Agreement reduces tariffs on British cars from 10% to zero.
Customs Unions: Members eliminate internal barriers and apply common external tariffs to non-members. Example: EU Customs Union (UK left post-Brexit). Simplifies trade within union but limits independent trade policy.
Single Markets: Allow free movement of goods, services, capital, and labour with harmonised regulations. Example: EU Single Market (UK participated pre-Brexit). Deepest form of economic integration short of monetary union.
Most Favoured Nation (MFN): WTO principle requiring equal treatment of all trading partners unless preferential agreement exists. Prevents discrimination between trading partners.
How Trade Agreements Affect Businesses:
Market access: Reduced/eliminated tariffs make exports more competitive in partner countries
Input costs: Cheaper imports of raw materials/components when tariffs removed
Competition: Foreign competitors gain easier access to domestic market
Supply chains: Businesses can optimize location of production/sourcing across multiple countries
Rules of origin: Must meet origin requirements (typically 50-55% local content) to qualify for preferential treatment
Real Business Example: Brexit Impact on Marks & Spencer
Context: UK left EU Single Market and Customs Union on 31 December 2020. Trade and Cooperation Agreement avoided tariffs on goods meeting rules of origin but introduced significant non-tariff barriers.
M&S Impact:
Store closures: Closed 11 French stores (May 2021) including Champs-Élysées flagship due to Brexit complexity
Customs procedures: Fresh food crossed UK-France border three times during production/distribution; each crossing required declarations (£20-100 each)
Reduced shelf life: Border delays significantly reduced fresh food shelf life, making French operations unviable
Separate supply chains: Required entirely separate operations for EU vs UK, duplicating infrastructure and inventory
Annual cost: Estimated £30+ million annually in increased logistics costs, customs administration, and lost sales
Simplified range: Reduced product range in remaining EU stores to minimize customs complexity
Functional Area Impacts:
Operations: Redesigned supply chains to minimize border crossings; increased inventory holdings to buffer delays; established new logistics hubs in EU (Rotterdam, Dublin)
Finance: Currency volatility increased hedging costs; cash flow pressures from delayed clearance; wrote off investments in cross-border integration
Marketing: Simplified EU product range; adjusted pricing to account for increased costs
HR: Visa requirements complicated EU worker hiring; established separate EU subsidiaries requiring new HR operations
Business Lesson: Trade agreement changes can make previously viable operations uneconomical overnight. Geographic diversification and supply chain flexibility become critical risk management tools.
2. Protectionism: Tariffs
Theory
Definition: Tariffs are taxes on imported goods, making them more expensive than domestic alternatives. Governments use tariffs to protect domestic producers from foreign competition.
Types of Tariffs:
Ad valorem tariffs: Percentage of product value (e.g., 10% of £100 import = £10 tariff). Most common type.
Specific tariffs: Fixed amount per unit (e.g., £2 per kilogram regardless of value)
Compound tariffs: Combination of both (e.g., 5% + £1 per unit)
Economic Impact of Tariffs:
Import prices increase: Tariff added to product cost, making imports less competitive vs domestic alternatives
Domestic producers protected: Higher import prices give domestic firms pricing power and market share protection
Consumer costs rise: Both import prices and domestic prices increase (domestic firms can raise prices knowing imports more expensive)
Government revenue: Tariffs generate tax revenue (though typically small proportion of total government income)
Retaliation risk: Trading partners may impose retaliatory tariffs, harming exporters
Real Business Example: US Steel Tariffs on UK Exports
Context: March 2018, US imposed 25% tariffs on steel imports under Section 232 national security provisions, affecting UK steel producers.
Impact on British Steel and Tata Steel UK:
Price shock: UK steel instantly 25% more expensive in US (£600/tonne became £750/tonne after tariff)
Volume collapse: UK steel exports to US fell 50% (£360m to £180m annually)
Revenue impact: British Steel lost £50m annually directly from tariffs
Market diversion: Steel diverted from US flooded other markets, depressing global prices 3-5%
Job threats: 4,000+ jobs at British Steel; 8,000+ at Tata Steel UK at risk
Business Responses:
Market diversification: Increased focus on Europe and Asia, though lower margins than US market
Product specialization: Shifted to high-value specialty steels where tariff impact smaller relative to product value
Operations: Reduced production volumes; shifted product mix
Finance: 5-8% revenue decline for UK steel sector; increased working capital needs
Marketing: Refocused sales on alternative markets and customers
HR: Workforce reductions; retraining for different products
3. Consumer Protection
Key UK Legislation
Consumer Rights Act 2015: Goods must be of satisfactory quality, fit for purpose, and as described. Services must be performed with reasonable care and skill. Provides rights to refunds, repairs, or replacements within specified timeframes.
Consumer Protection from Unfair Trading Regulations 2008: Prohibits misleading actions (false information about products/prices), misleading omissions (hiding important information), aggressive practices (harassment, coercion), and 31 specific banned practices.
Distance Selling and Online Regulations: 14-day cooling-off period for online/telephone purchases; clear information before purchase about total costs, delivery, cancellation rights; automatic refund within 14 days of cancellation.
Real Business Example: Volkswagen Emissions Scandal
Context: 2015, VW admitted installing "defeat device" software in 11 million vehicles worldwide (1.2 million UK) to cheat emissions tests.
Consumer Protection Violations:
Misleading information: Marketed as "clean diesel" when exceeding legal emission limits
Product not as described: Environmental performance substantially worse than advertised
Unfair commercial practice: Deliberate deception about product characteristics
Business Impact:
UK fine: £193 million
Global costs: €30 billion (recalls, compensation, penalties)
UK compensation: £193 million to 90,000 customers in class action
Market share loss: VW UK fell from 18% (2015) to 15% (2019)
VW Response: €35bn committed to electric vehicles by 2024; strengthened compliance; leadership changes; increased transparency in testing.
4. Employee Protection: Equality Act 2010
Key UK Employment Legislation
Equality Act 2010: Prohibits discrimination based on 9 protected characteristics: age, disability, gender reassignment, marriage/civil partnership, pregnancy/maternity, race, religion/belief, sex, sexual orientation. Covers recruitment, pay, promotion, training, dismissal.
Employment Rights Act 1996: Written contracts, minimum notice periods (1 week per year of service), unfair dismissal protection (after 2 years), redundancy rights, maternity/paternity leave.
National Minimum Wage Act: Minimum hourly rates by age (April 2024: £11.44 for 21+, £8.60 for 18-20, £6.40 for under-18/apprentices).
Working Time Regulations: 48-hour average weekly maximum (unless opt-out), rest breaks, night work limits, minimum 5.6 weeks paid annual leave.
Real Business Example: Tesco Equal Pay Claims
Context: 150,000 workers (predominantly female store workers) claim work equals distribution center work (predominantly male) but pays £1.50-3.00 less per hour.
Legal Basis: Equality Act 2010 requires equal pay for work of equal value. Claimants argue store work (serving customers, stocking shelves, tills) requires similar skill, effort, responsibility as warehouse work (picking orders, loading, inventory).
Business Impact:
Potential liability: £4 billion if Tesco loses (6 years back pay)
Industry-wide: Similar claims against Asda, Sainsbury's, Morrisons, Co-op
Impact: Sainsbury's share price fell 15%; Asda sold to Issa brothers/TDR Capital £6.8bn (2021); reduced likelihood of further retail consolidation.
6. Environmental Protection
Key UK Legislation
Climate Change Act 2008: Net zero carbon by 2050; emissions reporting required
Plastic Packaging Tax (2022): £200/tonne for packaging <30% recycled content
Extended Producer Responsibility: Businesses pay for packaging collection/recycling
Zero Emission Vehicle Mandate: Ban on new petrol/diesel cars from 2030
Real Business Example: Plastic Packaging Tax and Beverage Industry
Impact: £200/tonne tax on <30% recycled content created £10-15m costs for Coca-Cola; £80m potential liability industry-wide (400,000 tonnes annually).
Business Responses:
Material substitution: Coca-Cola increased to 50% recycled content; Highland Spring 100%
Supply chain development: Invested in UK recycling infrastructure for rPET supply
Alternative materials: Aluminum cans, paper bottles experimentation
Test Your Understanding: Political/Legal Environment Quiz
Question 1: How did Brexit create threats for M&S?
Question 2: Why did US steel tariffs harm UK producers?
Question 3: What consumer protection laws did VW violate?
Question 4: Why did CMA block Sainsbury's-Asda merger?
Economic Environment
Overview
The economic environment includes macroeconomic factors creating opportunities and threats. Changes affect costs, demand, and profitability across all functional areas.
Key Economic Factors:
Economic Growth (GDP) - Overall economic activity and expansion/contraction
Taxation - Direct (income, corporation tax) and indirect (VAT, excise duties)
Inflation - Rising general price level eroding purchasing power
Interest Rates - Cost of borrowing affecting investment and consumption
Functional Impacts: Operations departments adjust capacity in response to GDP-driven demand—expanding facilities and hiring during growth, closing facilities and implementing redundancies during recessions. Finance manages cash flow more tightly during recessions when credit becomes scarce and customer payments slow. Marketing shifts messaging between value-focused positioning during recessions and premium positioning during growth periods. HR adjusts hiring and retention strategies based on labor market conditions.
UK Business Example: 2008-09 Recession Impact
Woolworths collapsed into administration in November 2008 during the recession, closing all 800 stores and eliminating 27,000 jobs. The retailer couldn't adapt quickly enough to plummeting consumer spending and already struggled with an unfocused product range. When recession hit and consumers drastically cut discretionary spending, Woolworths' marginal position proved fatal.
In contrast, Poundland expanded from 200 stores in 2008 to over 500 by 2012, adding approximately 100 stores annually during and after the recession. Their value proposition—everything £1—resonated perfectly with cash-strapped consumers trading down. Similarly, Aldi and Lidl saw combined UK market share rise from 4% in 2008 to 8% by 2013 as consumers abandoned traditional supermarkets for cheaper alternatives. This demonstrates how the same economic condition (negative GDP growth) creates radically different outcomes depending on business positioning.
2. Taxation
Types and Business Effects
Direct Taxes (on income/profits):
Income tax: Reduces disposable income → less consumer spending → lower demand for businesses. Higher rates particularly affect discretionary spending (leisure, dining, luxury goods).
Corporation tax: Reduces post-tax profits → less retained profit for investment/dividends → may affect business expansion plans. UK rate: 25% for profits >£250k (2024).
National Insurance: Increases employment costs for businesses → may limit hiring or reduce wage increases.
Indirect Taxes (on spending):
VAT: Currently 20% standard rate in UK. Increases prices → may reduce demand, particularly for price-sensitive goods. Businesses collect VAT but burden ultimately on consumers.
Excise duties: Specific goods (alcohol, tobacco, fuel). High rates can significantly reduce consumption (tobacco taxes reduced smoking rates 30%+ over 20 years).
3. Inflation
Theory
Inflation is sustained increase in general price level. Measured by Consumer Price Index (CPI) in UK. Bank of England targets 2% annual inflation.
Causes of Inflation:
Demand-pull: Too much money chasing too few goods (strong economy, easy credit)
Cost-push: Rising costs (wages, raw materials, energy) passed to consumers
Import inflation: Weak currency makes imports more expensive
Expectations: If people expect inflation, they demand higher wages/prices, creating self-fulfilling spiral
Business Impacts:
Input costs rise: Raw materials, wages, energy, rent all increase. Question: can business pass costs to customers or must absorb?
Real incomes affected: If wages don't match inflation, consumer purchasing power falls → reduced demand
Pricing power crucial: Strong brands/differentiated products can raise prices; commodity products struggle
Planning difficulty: High inflation creates uncertainty, making forecasting and long-term planning challenging
Interest rate response: Bank of England raises rates to combat inflation → higher borrowing costs for businesses
UK Business Example: 2021-2022 Energy Cost-Push Inflation
Natural gas prices increased from approximately 50p per therm in early 2021 to peaks exceeding £4 per therm in late 2021 and 2022 following Russia's Ukraine invasion. This created severe cost-push inflation rippling throughout the UK economy.
British Steel estimated energy costs increased from £60 million annually to over £200 million. CF Industries temporarily closed its UK fertilizer plants when gas prices spiked, as production became uneconomical. Food manufacturers faced similar pressures—estimated production costs increased 15-20% during 2021-2022. These increases were passed through supply chains, with UK food inflation peaking at 19.2% in March 2023 (highest since 1977), directly resulting from energy cost-push inflation working through multiple sectors.
4. Interest Rates
Theory
Interest rates are cost of borrowing, set by Bank of England (base rate currently 5.25% as of late 2024).
When Rates RISE:
Borrowing costs increase: Business loans, mortgages, credit cards more expensive → reduces business investment and consumer spending on big-ticket items (houses, cars)
Saving more attractive: Higher returns encourage saving over spending → consumer spending falls
Mortgage costs rise: Variable rate mortgages increase monthly payments → less discretionary income → reduced consumer spending
Currency appreciates: Higher returns attract foreign investment → stronger pound → exports less competitive but imports cheaper
Cheaper borrowing: Business investment increases; consumers borrow for purchases
Saving less attractive: Low returns → consumers spend rather than save
Mortgage costs fall: More discretionary income → increased spending
Currency depreciates: Lower returns → weaker pound → exports more competitive but imports expensive
Increased demand: Especially credit-financed purchases
UK Business Example: 2022-2023 Rate Rises Impact on Housing
The Bank of England raised base rates from 0.1% in December 2021 to 5.25% by August 2023 to combat 11% inflation. Mortgage rates increased from 1-2% to 5-6% for typical two-year fixes. A buyer earning £50,000 who could afford a £300,000 property (£250,000 mortgage at 2% = £1,060 monthly) found the same mortgage at 6% cost £1,498 monthly—an increase of £438 monthly (£5,256 annually).
The housing market responded with transactions falling 20-30% and prices declining 5-10% in many regions. Persimmon's housing completions fell from over 14,000 in 2022 to projected 11,000 in 2023 (21% decline), forcing redundancies. First-time buyer numbers fell 20-25%, particularly impacting expensive areas like London where higher prices magnified affordability declines. This demonstrates interest rate effects: higher rates → reduced affordability → lower demand → sector contraction.
5. Exchange Rates
Theory
Exchange rate is price of one currency in terms of another (e.g., £1 = $1.27 means one pound buys $1.27).
Currency APPRECIATION (£ strengthens):
£1 = $1.20 → $1.30
Exports MORE expensive: UK product costing £100 changes from $120 to $130 for US buyers → less competitive → sales may fall
Imports LESS expensive: US product costing $100 changes from £83 to £77 for UK buyers → cheaper inputs → lower costs
Winners: UK importers, consumers buying foreign goods, businesses using imported inputs
Losers: UK exporters, domestic producers competing with imports, tourism industry (UK more expensive for foreign visitors)
Currency DEPRECIATION (£ weakens):
£1 = $1.30 → $1.20
Exports LESS expensive: UK product costing £100 changes from $130 to $120 for US buyers → more competitive → sales may rise
Imports MORE expensive: US product costing $100 changes from £77 to £83 for UK buyers → higher input costs
Winners: UK exporters, domestic producers competing with imports, tourism industry (UK cheaper for foreign visitors)
Losers: UK importers, consumers buying foreign goods, businesses using imported inputs
Calculation Formula:
Export price in foreign currency = UK price (£) × Exchange rate
Import cost in UK currency = Foreign price ($) ÷ Exchange rate
UK Business Example: Brexit Referendum Pound Depreciation (2016)
Following the June 2016 Brexit referendum, the pound fell from approximately £1 = $1.48 to $1.30 within days—a 12% depreciation (eventually stabilizing 15-20% below pre-referendum levels).
For exporters: UK manufacturing export orders surged, with PMI reaching 56.9 in November 2016 (highest since mid-2014). Rolls-Royce, JCB, and other manufacturers benefited as UK products became more competitive internationally.
For importers: Consumer electronics saw prices rise 5-10% by late 2016—Apple increased iPhone prices from £539 to £599. Unilever demanded 10% price increases from Tesco in October 2016 to cover higher import costs for brands like Marmite and PG Tips. Tesco briefly delisted Unilever products before accepting partial increases.
Inflation impact: UK CPI inflation rose from 0.5% in June 2016 to 3% by late 2017, significantly above the Bank of England's 2% target, primarily driven by import price increases from pound depreciation. This created a cost-of-living squeeze as wages didn't initially keep pace.
6. Unemployment
Theory
Unemployment rate measures percentage of workforce actively seeking work but unable to find jobs. UK currently ~4% (2024).
HIGH Unemployment (>7%):
Lower consumer spending: Unemployed have reduced income; employed worry about job security → cautious spending
Easier recruitment: Large pool of candidates; employers can be selective; wage pressures lower
Government spending increases: More benefits paid → may require higher taxes or borrowing
Social costs: Higher crime, health problems, reduced well-being
LOW Unemployment (<4%):
Higher consumer spending: More people earning; greater confidence → increased demand