The PEST Analysis

The PEST analysis has proven to be a flexible and easy to understand tool in the context of strategic planning. As with any other tool, the real value of the PEST analysis depends on the way it is used. Hence, the following article not only describes the content of this tool, it also provides advice for its practical application and interpretation.

Elements of a PEST analysis

The PEST or PESTLE is a useful starting point for the analysis of an organizations external environment and the forces at work there.

PESTLE stands for political, economical, socio-cultural, technological, legal and ecological factors. There are different opinions in literature about the inclusion of legal and ecological factors. Their importance differs from industry to industry. In case such factors are of high relevance to an industry, they should be analyzed in the L and E section. In industries that are less influenced by legal and ecological factors, they could be allocated to the other categories, e.g. legislation as a political factor or ecological awareness as a socio-cultural factor.

In any case it is important to include only external factors which an organization cannot influence by itself. It seems to be a widespread problem to correctly distinguish between external and internal factors. The PEST only refers to drivers from the organizations external environment.

The following example shows some typical content of a PEST analysis. These examples are not comprehensive; they should be modified and complemented according of the actual subject of analysis.

Political

• Legislation (current and pending)
  • Laws relating to the industry
  • Tax laws
  • Regulation of transfer for capital and labour
• Stability of the political system
• Membership in free trade areas
• independence and efficiency of courts to enforce contracts

Economical

• Development of relevant economic indicators
• Business cycles
• Unemployment, availability of skilled labor
• Availability of relevant resources
• Key industries, industrial clusters
• Industry structures
• tax system

Socio-Cultural

• Population and demographics
  • Distribution of income
  • Mobility
  • Level of education
• Customer behavior
  • Savings rates
  • Preferences for branded / unbranded products
• Cultural and religious rules influencingbusiness activity

Technological

• Technological level of
  • The economy
  • The own industry
  • Supplier and customer industries
• State and private R&D expenses
• Lifecycle phases of relevant products
• Pace of technological progress

Application of the PEST analysis

The PEST tool can be used to analyze companies, business segments, industries, particular product markets or whole economies. Hence, it can be applied to a business or to a market (product or regional). Used for the analysis of markets, the PEST can even serve as a standard presentation format to compare several markets that were analyzed (e.g. for global location decisions).

Thus the PEST provides a summary of the driving forces in the macro environment. It is advisable to include factors that influence the business today and such that may gain importance in future. Depending on the objective of the analysis, a distinction between the current situation and potential future changes may be helpful.

It is important to remember that the tool in the form described above just lists relevant factors for the subject of analysis. Such a listing is itself devoid of much strategic meaning. In order to gain insights from this tool, the PEST can be used in two different ways:

The PEST as starting point for further analysis

In order to gain really meaningful results it is not enough to understand the PEST analysis as a mere list of drivers. It rather is a starting point for further analysis of the external environment.

In this context, the PEST is a tool to compile all potentially relevant factors and to sort them into meaningful groups. This could be, for instance, the result of a brainstorming exercise. The content of this compilation still needs to be analyzed further.

An important step is to identify those forces that are potential major drivers for change. These are such drivers that are highly likely to influence and change the industry structures or market structures. These drivers need further analysis. The following excursus provides some ideas.

One approach would be to look for different drivers that, in combination, will probably lead to a common result. For example, the simultaneous observation of the factors deregulation of trade barriers, improvement of communication technology, increasing competitive pressure on local markets, and converging customer preferences are likely to be drivers for further globalization.

Starting from the PEST anlaysis it is possible to analyze the different levels of impact that particular drivers will have on an organization. An impact-uncertainty-matrix is a helpful means for visualization.

It may also be helpful to assess the impact of the most important drivers on the organizations’ competitors. Provided there is sufficient information available about the competitors’ competences, strengths and weaknesses, it is possible to derive ideas about

• the extent to which a competitor may be able to exploit new chances or to handle risks arising in the environment
• how the competitor might react to these changes

The following example illustrates how the impact of an identified driver can be analyzed further. This example relates to the business of housing finance.

Driver:

• pending changes in legislation on housing finance and mortgage finance in a particular country (P – political factor): The government plans to deregulate mortgage financing in order to harmonize this industry with international standards

Questions to think about:

• Which business opportunities will be legally feasible for foreign banks? (P – political issue)
• Is this market economically attractive, e.g. is the market large enough to achieve economies of scales; will it be possible to realize sufficient margins? (E – economical issue)
• Will the players in the local market (especially retail customers) accept foreign financial services providers? (S – socio-cultural issue)
• Which international competitors might enter this market? What kind of services will they probably offer and how will they do so? (E – economical issue – competitor analysis)
• Should our own organization enter this market? (strategic option)

The PEST analysis as a summary of findings

An alternative is to put the PEST tool at the end of a detailed analysis process for the external business environment. Used in this way, it should not just list some relevant factors without much explanation. Here it is essential to provide statements about the strategic impact of these factors.

When using the PEST anlaysis in this way, nobody should feel obliged to fill in all sections. If there is no relevant political driver, it doesn’t do any good to add a minor factor, just to have something written in the P-section.

Summary

The PEST analysis is a popular tool for the strategic analysis of external factors. It is applicable to various subjects of research.

The application of the PEST-format (allocation of external factors to four categories) has proven useful in practice in two ways:

• For compiling and structuring of information
  Normally, huge amounts of information are compiled in early stages of the analysis of new markets or business segments. Pre-sorting this information into the four PEST-categories can help to get the general idea and will serve as a starting point for further structuring of the relevant pieces of information. Used in this way, the PEST will naturally comprise comprehensive and detailed lists.
• As a means of presentation
  The PEST-scheme is a helpful structure for presentations, e.g. of the results of market analyses. Here it can serve as an executive summary. The PEST offers an easily comprehensible presentation structure since it is widely known and easy to understand.

By Dagmar Recklies, 2015

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