Understanding political and legal change is essential for strategic business planning, especially as external shifts can greatly affect decision-making and operations.
The Political and Legal Environment: Definition and Importance
What is the Political Environment?
The political environment refers to the external influence of government actions, political ideologies, policy shifts, and global diplomatic relations on business activity. It encompasses factors such as:
Government stability – e.g. stable governments create predictable conditions, while political unrest increases uncertainty.
Election outcomes – different parties often bring different policies, affecting taxation, spending, and business regulation.
Trade policies and foreign affairs – including trade agreements, tariffs, sanctions, and diplomatic relations.
Public spending priorities – including decisions around infrastructure, education, or healthcare, which can directly or indirectly benefit certain sectors.
Governmental attitudes towards business – pro-business vs interventionist governments can create very different environments.
A favourable political environment can encourage investment, innovation, and market growth. Conversely, political instability or hostility towards business can discourage long-term planning.
What is the Legal Environment?
The legal environment refers to the framework of laws, statutes, and regulations that govern how businesses operate. These include:
Labour legislation – such as minimum wage laws, employment contracts, and health and safety.
Taxation law – including corporation tax, VAT, and capital gains tax.
Environmental regulations – emissions standards, waste disposal, and sustainable sourcing.
Competition law – rules preventing monopolies, price fixing, and promoting consumer choice.
Consumer protection – covering refunds, warranties, product liability, and advertising.
Businesses must operate within the boundaries of the legal environment, which is set and enforced by public authorities. Unlike internal changes, companies have no direct control over the political or legal environment, making external monitoring and agility crucial.
Why Does This Matter for Business?
Both political and legal factors:
Influence decision-making across all levels of a business.
Create risks (e.g. penalties, rising costs) and opportunities (e.g. tax reliefs, new markets).
Require companies to remain compliant, adaptable, and forward-looking.
Companies that fail to monitor and respond to these changes risk losing their competitive edge or even facing legal consequences.
Political and Legal Change and Business Decision Making
Strategic vs Functional Decisions
Strategic decisions are concerned with the long-term direction of a business. These might include expanding into new countries, launching new product lines, or entering mergers and acquisitions.
Functional decisions are made at the department level and deal with day-to-day operations, such as staff scheduling, marketing spend, or inventory management.
Political and legal changes affect both, and successful companies must integrate external monitoring into both strategic and functional planning.
Examples of Strategic Impact
A major change in trade policy, such as the imposition of tariffs, might lead a business to reconsider international expansion or source materials domestically.
Introduction of carbon taxes might encourage strategic investment in sustainable technologies or green R&D.
A change in corporate tax policy could shift decisions on profit reinvestment or dividend payouts.
Examples of Functional Impact
Minimum wage increases might lead HR departments to revise pay structures or reduce staffing hours.
New advertising laws could cause marketing departments to change messaging, remove misleading claims, or alter packaging.
Legal changes in return policies may prompt customer service teams to update procedures and staff training.
Examples of Political and Legal Change in Action
Brexit
The UK’s departure from the EU represents one of the most influential political events for British business in recent decades. It triggered widespread effects on trade, regulation, and labour markets.
Impacts on business:
New customs and border checks increased lead times and logistics costs for importers and exporters.
Loss of passporting rights in financial services caused banks to relocate staff and services to EU countries.
Exchange rate volatility created price uncertainty for businesses trading in euros or dollars.
Strategic decisions included setting up EU subsidiaries or seeking non-EU markets for diversification.
National Minimum and Living Wage Reforms
In the UK, the introduction and periodic increase of the National Minimum Wage (NMW) and National Living Wage (NLW) have significantly affected businesses.
Functional impacts:
Rising wage bills, especially in sectors like hospitality, retail, and care.
Reductions in staff hours, use of zero-hour contracts, or increased use of automated systems to reduce reliance on human labour.
Increases in prices to pass costs onto consumers.
Strategic responses:
Relocation of operations to lower-wage regions or countries.
Investment in technology and training to increase labour productivity.
Trade Sanctions and Tariff Policy: U.S.-China Trade War
Although primarily between the US and China, global businesses felt the effects of the trade war due to supply chain interdependence.
Examples:
UK firms relying on Chinese electronics faced price hikes due to US tariffs, causing indirect supply chain disruptions.
Strategic choices included reshoring (moving production back to the UK) or diversifying suppliers across Asia and Eastern Europe.
Key Areas of Business Impact
Operations
Legal and political changes directly affect how a business runs on a daily basis. These include:
Health and safety rules that mandate staff training and equipment.
Consumer law that governs product standards and recalls.
Import/export documentation requirements that can increase operational complexity.
Financial Costs
Changes in taxation, regulation, and labour law can all lead to:
Increased overheads (e.g. compliance costs, hiring legal teams).
Investment in new systems (e.g. for GDPR compliance).
Fines for non-compliance, often with reputational damage.
Firms must carefully assess these costs during budgeting and forecasting processes.
Investment
Government stability and law influence investor confidence. For example:
Political instability may delay or deter investment, especially from foreign sources.
Consistent and business-friendly laws encourage venture capital and foreign direct investment (FDI).
Competitiveness
Changes can either enhance or reduce a firm’s competitive advantage:
If a firm adapts better or faster to a new regulation, it might gain first-mover advantage.
Conversely, new laws may benefit competitors in other countries with less regulation.
How Businesses Monitor and Respond to Change
Environmental Scanning
Businesses must be proactive in monitoring their environment through:
Political risk analysts and industry reports.
Participation in trade associations and business forums.
Subscribing to government consultations and policy updates.
The goal is to anticipate and prepare, rather than react late.
Scenario Planning
Scenario planning involves asking "what if?" and preparing responses in advance.
Examples:
A UK manufacturer may plan different responses to UK-EU trade policies: one where tariffs increase, and one where trade is frictionless.
A hospitality business may plan for increases in minimum wage and evaluate whether they can afford to retain current staffing levels under different scenarios.
Regulatory Affairs and Legal Compliance
Large businesses often maintain a legal or compliance department, responsible for:
Interpreting laws and advising on risks.
Implementing compliance procedures (e.g. for data protection).
Liaising with regulators or submitting required documentation.
In smaller firms, this may fall to external consultants or legal advisers.
Risk Management
Risk management teams assess political/legal threats alongside other risks, such as economic downturns or technological disruption.
Risk assessments often consider:
Likelihood of the political or legal change happening.
Impact on different parts of the business.
Mitigation strategies, including insurance, diversification, or lobbying.
Summary of Business Response Strategies
To respond to political and legal change, businesses often:
Adapt functional strategies, e.g. altering production, marketing, or HR practices.
Revise strategic direction, e.g. change markets, withdraw from investments, or reposition brands.
Invest in staff training, systems, or infrastructure to comply with new rules.
Liaise with regulators and participate in policy discussions to influence outcomes.
Important Points for AQA A-Level Students
Political and legal change is a core component of external influences in strategic analysis.
These changes affect both long-term strategic planning and short-term operational decisions.
Companies must monitor their external environment and be flexible in how they respond.
Real-world examples like Brexit and wage reforms help show how theoretical concepts apply to actual business decisions.
Tools like scenario planning, environmental scanning, and compliance auditing are essential for navigating change.
Understanding how businesses respond to these changes is key for analysing their strategic position and long-term viability.
FAQ
Businesses often engage in political lobbying to influence legislation or regulatory decisions that may impact their operations. This is typically done through direct communication with lawmakers, funding research, or supporting trade associations. For example, large firms may lobby against strict environmental regulations that could increase production costs. Lobbying can shape government priorities, delay regulatory implementation, or secure favourable treatment such as tax relief or subsidies. It is a strategic tool used to minimise risk and align the external environment with business objectives.
Multinational corporations operate across multiple countries, each with its own political and legal systems. Changes in any of these environments can affect compliance obligations, tax liabilities, labour practices, or trade logistics. For instance, a shift in trade policy in one country could disrupt the entire supply chain. MNCs must monitor political developments globally and implement risk mitigation strategies like diversifying production bases or engaging local legal experts to ensure continued operational efficiency and legal compliance.
Political risk analysis helps businesses anticipate potential disruptions caused by political instability, policy changes, or legal reforms. It involves evaluating the likelihood of events such as regime changes, nationalisation, or new legislation that could affect profitability or continuity. Companies use this analysis during market entry, investment planning, or mergers to avoid costly surprises. It informs contingency planning, insurance needs, and strategic decisions like whether to proceed with expansion or delay until the political environment stabilises.
Political and legal shifts can have significant implications for supply chains, including the imposition of tariffs, customs checks, and trade restrictions. A new legal requirement may demand supplier certification or product re-labelling. Political unrest in supplier regions may delay shipments or force firms to seek alternative vendors. In response, businesses may reconfigure logistics routes, build inventory buffers, or localise sourcing to reduce exposure. These changes ensure resilience and compliance while maintaining cost control and customer satisfaction.
Small businesses typically have fewer resources to monitor and adapt to political and legal changes, making them more vulnerable to sudden shifts. They may lack dedicated legal or compliance teams and are more affected by changes such as tax hikes or regulatory burdens. In contrast, large corporations often have established procedures, lobbying power, and legal departments to navigate changes efficiently. Small firms tend to react by adjusting operations quickly, such as reducing staff or delaying investment, while larger firms plan strategically in advance.
Practice Questions
Analyse how a significant political change such as Brexit could affect the strategic decision making of a UK-based manufacturing business. (10 marks)
Brexit introduces uncertainty in trade relations, tariffs, and labour mobility. A UK-based manufacturer may alter its strategic decisions by relocating parts of its supply chain to the EU to maintain tariff-free access, or by investing in domestic sourcing to avoid import barriers. Regulatory divergence from the EU could require product redesign or re-certification. Additionally, loss of EU workers may lead to recruitment challenges, influencing investment in automation. Overall, Brexit would push the firm to reconsider market focus, production locations, and long-term capital allocation to mitigate political risk and remain competitive in the post-Brexit environment.
Assess the impact that an increase in the National Living Wage might have on the functional decisions of a retail business. (10 marks)
An increase in the National Living Wage raises staff costs, prompting a retail business to revise functional decisions in HR and operations. The business might reduce staff hours, limit recruitment, or introduce more flexible contracts to manage wage inflation. Alternatively, it could invest in self-service technology to reduce reliance on labour. Prices may be increased to maintain margins, affecting marketing and pricing strategy. Training could focus on multi-skilling to increase staff efficiency. Overall, the wage rise necessitates cost management responses that affect staffing structures, operational efficiency, and pricing within the business’s day-to-day functional activities.
