PESTEL Analysis is a one of the strategic framework tools commonly used to assess the business environment in which a company operates. Traditionally, the framework has been referred to as PESTEL analysis, an acronym for political, economic, social, technological, environmental, and legal factors; in more recent history, the framework has been expanded to include environmental and legal aspects.
The framework is used by management teams and boards in their strategic planning processes and enterprise risk management planning. PESTEL analysis is also a vital tool with management consultants who help their clients develop innovative product and market initiatives, as well as with financial analysts where the factors can inform model assumptions and financing decisions.
The factors of a PESTEL analysis can be mixed into other industry and business framework tools such as the Ansoff matrix, Porter’s 5-factor analysis, and the SWOT analysis.
In the broadest sense, political factors are those determined by government actions and policies. These include considerations such as:
- Corporate taxation
- Other tax policy initiatives
- Free trade disputes
- Antitrust and other anti-competitive issues
It is worth noting that even the overhang of potential trade disputes or antitrust issues can present significant risks and opportunities for management teams. Differing parties’ positions on the left and right on crucial election platform issues can also create unique challenges for a company’s management team in the run-up to elections, as the range of potential outcomes can vary significantly depending on the election results.
Example of a political factor: A multinational company closes several sites in a high-tax country to relocate its operations to a place with lower tax rates and better government financing and subsidy opportunities.
Also, Read The Example of PESTLE Analysis in a Simplified Way to get better understanding.
Economic factors refer to the economy in general and are usually explicitly financial. They include:
- Interest rates
- Employment rates
- Exchange rates
Many financial service analysts tend to overweight economic factors in their analysis because they are easier to quantify and model than some of the other factors in this framework (which are more qualitative in nature).
Example of an Economic Factor: depending on where we are in the economic cycle and how government bond yields are performing, an equity analyst may adjust the discount rate in their model assumptions; this can have a significant impact on the valuations of the companies they cover
Social factors are generally more difficult to quantify than economic factors. They refer to changes in how stakeholders live and spend their leisure time, which can affect business activity. Examples of social factors are:
- Demographic considerations
- Lifestyle trends
- Consumer beliefs
- Attitudes toward working conditions
Social factors may seem minor compared to tangible things like interest rates or corporate taxation. Yet they can have a shockingly significant impact on entire industries as we know them. Just think about how the trend toward healthier and more active lifestyles has ushered in the development of connected fitness technologies and how it has changed the types of foods we consume and how they are packaged and marketed.
Social Factor Example: After the pandemic, management at a technology company had to rethink its hiring, onboarding, and training practices after an overwhelming number of employees indicated that they preferred a hybrid model of working from home.
In today’s business landscape, technology is ubiquitous and changing fast. Both management teams and analysts must understand how technological factors impact a company or industry. These include, but are not limited to:
- How research and development (R&D) can impact both costs and competitive advantage
- Technology infrastructure (such as 5G, IoT, etc.)
- Cyber security
The speed and scale of technological upheaval in today’s business environment are unprecedented and have a devastating impact on many traditional businesses and sectors – think Uber upends the transportation industry or the emergence of e-commerce revolutionizing retail as we know it.
Technology Factor Example: A management team must weigh the practical and financial implications of moving from on-site physical servers to a cloud-based data storage solution.
Environmental factors became a valuable addition to the original PEST framework when the business community began recognizing that changes in our physical environment can present significant risks and opportunities for organizations. Examples of environmental factors include:
- Carbon footprint
- Climate change impacts, including physical and transition risks
- Increasing occurrence of extreme weather events
- Responsible use of natural resources (e.g., freshwater)
The environmental factors in a PESTEL analysis overlap significantly with those typically identified in an ESG (environmental, social, and governance) analysis. The inclusion of environmental factors in the PESTEL analysis framework is due to the growing popularity of movements such as CSR (corporate social responsibility) and ESG.
Example of an Environmental Factor: management of a publicly traded company must re-evaluate internal record-keeping and reporting tools for tracking greenhouse gas emissions after the stock exchange announced mandatory climate and ESG disclosures for all publicly traded companies.
Legal factors arise from changes in the regulatory environment that can impact the overall economy, specific industries, or even individual companies within a given sector. These include, but are not limited to:
- Regulation of the industry
- Licenses and permits required for business operations
- Labor and consumer protection laws
- IP (intellectual property) protection
Regulation can serve as a headwind or a tailwind for operators. An example of a headwind would be increased capital requirements for financial institutions; a tailwind would be when regulation in a particular industry (e.g., food production) is so strong that it serves as a protective barrier for incumbents and creates an additional barrier for potential entrants.
Example of Legal Factors: a credit rating agency evaluates a technology company’s creditworthiness with significant growth prospects in emerging markets. The analyst must balance this growth path against the inherent risk of intellectual property theft in some countries with weak legal infrastructure. Intellectual property theft can significantly impact a company’s competitive advantage.
How PESTEL Analysis Can Help Businesses To Grow?
An analysis of PESTEL provides contextual information about the company’s direction, brand positioning, growth objectives, & risks (such as another pandemic or natural disaster) to productivity. It can help determine the validity of existing products and services and define new product development.
The Limitations of PESTEL Analysis
While PESTEL analysis is popularly used in business practice, critics point out its limitations. PESTEL analysis can help explain market changes in the past. Still, it is not always helpful in predicting or anticipating market changes because PESTEL analysis offers a wide range of categories that can be deceptively simplistic. After all, they do not include specific criteria about what exactly triggers a disturbance. In other words, the PESTEL analysis offers no guidance on what should and should not be within the categories. As a result, companies can be surprised by disruptions that do not fit clearly into the classes.
Advantages & Disadvantages of PESTEL Analysis
- It is a simple framework.
- It facilitates an understanding of the broader business environment
- It encourages the development of external and strategic thinking
- It can enable an organisation to anticipate future business threats and take action to avoid or minimal their impact.
- It can enable an organisation to identify business opportunities and take full advantage of them.
- Some users of PESTLE analytics oversimplify the amount of data used to make decisions – it is easy to use too little data.
- The risk of collecting too much data can lead to “paralysis by analysis.”
- The data may be based on assumptions that later turn out to be unfounded.
- The pace of change makes it increasingly difficult to predict future developments that may impact an organisation.
- To be effective, the process must be repeated regularly.
PESTEL and Financial Analysis
The above six factors can profoundly impact a company’s risks and opportunities. The analyst community must recognise these and attempt to quantify them in their financial models and risk assessment tools.
Some examples include:
- Financial analysts can adjust model assumptions such as revenue growth rates and gross margins based on inflation expectations.
- A company that has mismanaged its carbon footprint may be subject to fines or carbon tax levies in the future, so analysts should plan for an adequate cash reserve.
- A changing macroeconomic environment may require rating agency analysts to plan for a higher interest rate buffer for sensitivity analysis when calculating a company’s debt service coverage ratio.
- A massive level of automation in a particular industry is expected to reduce labor costs by X% – which would significantly change free cash flow estimates in a financial model.
- Wikipedia. https://en.wikipedia.org/wiki/Strategy
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