PEST Analysis of the firm’s external macro environment

In 1960s, researchers studied model and framework for analyzing the macro-environment in organizational strategy management. Aguilar (1967) studied the tools and techniques of macroeconomic analysis by introducing the ETPS analysis that focuses on Economic, Technological, Political, and Social environment. The last one was upgraded by Arnold Brown into STEP (Strategic Trend Evaluation Process) in terms of how to evaluate strategic trends. However, it wasn’t until 1970 that this framework was really attracted the attention and widely accepted by researchers and strategic managers under official name of PEST analysis (Political, Economic, Social and Technological analysis) used in the environmental scanning component of strategic management.

1. Main contents of PEST analysis

PEST is a simple and useful analysis tool allowing strategic managers to capture an “general vision” of the firm’s macro-environment. Up to now, the PEST analysis is widely used with its four basic macro-environmental factors, including:

Political environment

The political environment has a direct impact on almost aspects of firm’s activities by constraining what products and services are allowed and not allowed legally being produced? Political factors frequently considered in PEST analysis include:

Political stability is mainly related to political conflicts and diplomacy of legal institutions. Stable institutions create favorable conditions for business activities and vice versa.

Laws: Some ones such as investment law, tax law, labor law, environmental law, etc. and policies of trade, industry development, competition regulation, consumer protection, … form the legal framework of firms’ business environment. Firms understanding and obeying the laws can take advantage of the opportunities created from the legal provisions; and also, can take timely measures face to changes in laws by limiting the damage resulted from ignorance of the business laws.

The extent of governmental intervention: Government provides the legal framework and public services to firms; and also, it controls and stimulated the firms’ activities. So, firms can run more smoothly their business when they fit with the government intervention in their sectors.

Other political factors can be considered such as tax policy, trade restrictions, tariffs, Regulation and deregulation.

Economic environment

Economic factors influence directly and continuously affect the firms’ activities and development (Gillespie, 2007). Some important ones are the following:

Economic growth (GDP): A high growth of GDP can stimulate demand by creating development opportunities for firms.

Monetary policy and exchange rate: A strong currency can make exports more difficult because off high exchange rate, so by affecting the trade balance off the country, that also has some impact on foreign investments.

Market orientation: The capitalist or socialist orientation of the market affects the firm’s development path.

Interest rates and interest rate trends: High interest rates may hamper investments as firms have to pay more for loans. In addition, high interest rates make consumers tend to save instead of spending by resulting the decreasing demand in the country.

Inflation: Inflation can make an increasing demand for labor wages, which in turn increases costs of firms. Too high inflation discourages savings and raises investment risks, while deflation causes economic stagnation.

Economic development level: Economic development at a high level creates favorable conditions for business development; in contrast, a low level of economic development makes it difficult for firms to survive.

Infrastructures and natural resources: These are the input off firms. Good infrastructures stimulate business development. Abundant natural resources provide raw materials for national industries.

Other economic factors can be considered such as trade balance, foreign investment, financial system ….

Social environment

Social factors influence market demand as well as employees’ personal opinions, which affect the firm’s business. Social factors frequently considered are:

Cultural standards and values: They determine the ways in which employees live and work, consumers’ trends to use products and services of the firm.

Population, population growth rate and age structure: The young or old population determines the consumption trend of society; the country demographic provides information for the firm’s product orientation. For example, the aging population tend to increase the drugs demand while the toys demand is likely to decrease.

Urbanization: The higher the urbanization rate, the higher the change in social factors and the tendency to integrate into the international market.

Professional attitudes in each industry form the rational of employees or consumers towards firms in such industry, which can create advantages or disadvantages for firms in producing and supplying their products and services.

Other social factors can be considered such as location, lifestyles, family size, ethnic background, health consciousness, culture and sub-cultures.….

Technological environment

New technologies reduce costs, improve quality and lead to further innovations. In addition, technologies and technical innovations can also generate new products and new processes. Online shopping, coding and automations improve the business environment by making benefits for firms and consumers.

Research and development (R&D): The raise and development of technology creates new products that are more suitable for consumers, but also increases the rival competition for firms. In general, the more a firm invests in R&D, the more business opportunities will emerge.

Technology cycle: The explosion of technology in recent decades shortens the technology cycle by increasing pressure for existing firms face to new entrants.

Copyright: The protection of technology copyrights allows firms to master professional know-how, to obtain sustainable competitive advantage, and ensure their sustainable development.

Other technological factors can be considered such as wireless, POS systems, cybersecurity, online databases, debit/credit machines, distribution and supply chains, AI.

Additional factors forming the PEST variations

In addition to the PEST analysis with four basic environmental factors above, this framework can be expanded into some variations depending on researchers’ and managers’ needs. The main variations include:

  • PESTLE / PESTEL analysis includes: Political, economic, social, technological, legal, and environmental factors.
  • PESTLIED analysis includes: Political, economic, social, technological, legal, international, environmental, and demographic factors.
  • STEEPLE analysis includes: Social / demographic, technological, economic, environmental, political, legal, and ethnic factors.
  • SLEPT analysis includes: Social, legal, economic, political, and technological factors.
  • SPELIT Power Matrix include the Ethical, Educational, Physical, Religious, and Security environments.

In which, legal environment concerns the discrimination law, consumer law, antitrust law, employment law, and health and safety law. These factors may affect the firm’s operations, production costs and consumption demand.

Natural environment and Ecology concerns weather, climate change, geographical location, natural landscape … that influence directly some industries such as tourism, livestock, insurance … In addition, the population awareness about the impacts of climate change can also have some impacts on the firm’s business.

Demographic environment relates to gender, age, ethnicity, beliefs, consumption habits, income … that can affect the demand for products and services of the firm.

Society includes culture, customs and habits of consumers, thereby affecting the firm’s business.

International environment concerns the stability of the world economy and politics, trade treaties, government agreements, non-governmental organizations … which have impacts on the national economy, and so the firm’s business.

Inter-cultural factors consider the collaboration in a global setting.

Other business-related factors that might be considered in an environmental analysis include Competition, Demographics, Ecological, Geographical, Historical, Organizational, and Temporal (schedule).

2. Application and examples

The PEST analysis is often built on the basis of secondary data in three steps:

Step 1: Determining the target industry or sector, and collecting macro information related;

Step 2: Identifying factors affecting the target industry or sector; and distributing an assessment score for each factor;

Step 3: Analyzing and making conclusions about the impact of macro-environmental factors.

To clarify how to establish the PEST analysis, please see practical examples here !

3. Advantages and disadvantages

PEST framework has some advantages, including:

– In general, a good PEST analysis clarifies main environmental factors affecting the firm’s business by contributing to the making-decision process of strategic managers. By capturing environmental changes, the firm can profit new business opportunities to adapt to the market rather than resist them.

– PEST analysis appears particularly useful when firm start business in a new area such as international market. It allows firm and its managers having an “general vision” on the macro-environment for strategic decisions and quick adaption to a new environment.

However, the PEST framework includes also some disadvantages:

The external factors in the PEST analysis change continuously. Sometimes, these changes take place for less than a day; therefore, it is difficult to predict why and how these factors may affect the business strategy at present or in future. In some cases, these changes can be recognized, but no attention paid in the early stages results serious consequences on the strategy outcome.

The PEST structure is simple. Usually, analysts introduce a list of macro environmental factors; but only some ones influence really the firm’s business; a major of them can be ignored at the time of analysis.

– The data collection of the environmental factors is often difficult. This makes the PEST analysis expensive both in terms of time and cost. Additionally, updating the PEST analysis is also challenging.

– A good PEST analysis requires a lot of information to collect; and when dealing with too much information, analysts are often confused in determining which factors are important and that can lead to mistakes.

– The PEST analysis is not enough for strategy planning because it ignores the internal environment and competitive factors. PEST analysis needs to be combined with other analyses to be more useful for firms.

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