Decision making by firms is often subject to certain restrictions or constraints, which may be internal or external. The internal constraints refer to the ones imposed by the organization itself. For example, while deciding on what to produce, a firm might not like to explore each and every alternative goods or services it could produce. If the promoter, for example, is a fresh engineer with a little money of his own and is a risk averter, he might consider only a handful of small manufacturing firms to choose just one amongst them. Instead, if the promoter is a rich person, owning a vast business enterprise and has the objective of creating employment for unskilled workers, he might decide to establish a handloom unit. Similarly, entrepreneurs with socialist leanings, may produce the essential goods and sell them at no-profit-no-loss basis. These are some examples of internal constraints which have a significant effect on management decisions.
Among the external constraints, the important ones are resources constraints, output quantity or quality constraints, legal constraints and environmental constraints. A brief discussion of these follows.
Certain resources might be available in a fixed or limited quantity and the firm has to take the most appropriate decision. For example, for a small entrepreneur, capital would be a constraint. Similarly a raw material might have to be imported and there may be an import restriction or it might be locally available, but only in a limited, in which case, the firm has to decide within this constraint. Also, sometime skilled labor, plant and machinery, or electricity, or even the house space could be a binding constraints for the expansion of a firm. Such constraints are of particular significance in a resource-scarce country like India.
Production of several products may require licenses or formal approvals from a competent authority. Since these are issued for installing a certain unit of maximum capacity, they become a constraint to the firm and such constraints are sometimes dictated by the availability of the market. The authority might prescribe certain quality norms, which the organization must adhere to. Some common examples of output quality constraints are nutritional requirements for feed mixtures, audience exposure requirements for media promotions, reliability requirements for measurement devices, and requirements for minimum customer service levels.
The legal constraints on firms’ behavior take the form of laws that define minimum wages and bonus, health and safety standards, pollution emission standards, fuel efficiency requirements, price controls including taxes and subsidies, import export quotas and tariffs, fair marketing practices, priority lending and differential interest rates on loans, backward area subsidies, differential tax rates and so on. All these constraints impose restriction on managerial flexibility. Taking a decision require thorough understanding of all these restrictions and facilities.
No firms can afford to ignore the economic, social and political environment within which it has to function. It needs to understand these spheres not only within the economy but also in the world outside since most economies are open economies in the present day context. The manager must have a good knowledge about all the aspects of public policy, such as those dealing with plan objectives, taxation, subsidies, industrial policy, import-export policies, technology, foreign exchange, regulation etc. Besides, he must understand the trends in all pertinent aggregate variables such as national income, price level, unemployment, poverty level (both absolute and relative), export import, money supply, interest rate and foreign exchange balances. In addition, he would keep track of the changing political situation and social environmental in the country. It is almost impossible for the top management to be well informed about these matters. They therefore employ the service of economists or Financial consultants to constantly monitor the economy vis-à-vis their particular firm and appraise the management about forthcoming changes.