Understanding the context in which firms operate is essential for collecting and interpreting data on business innovation. The systems view of innovation stresses the importance of external factors that can influence a firm’s incentives to innovate, the types of innovation activities that it undertakes, and its innovation capabilities and outcomes. External factors can also be the object of a business strategy, public policy or concerted social action by public interest groups. This chapter discusses the characteristics of the firm’s external environment that can influence innovation and the associated challenges and opportunities that managers need to consider when making strategic choices, including for innovation. These factors include the activities of customers, competitors and suppliers; labour market, legal, regulatory, competitive and economic conditions; and the supply of technological and other types of knowledge of value to innovation.