What is a PESTEL Analysis?
Management teams and boards use the framework as part of their strategic planning and enterprise risk management planning.
PESTEL analysis is also a very popular tool among management consultants, who use it to help their clients come up with new products and market ideas. It’s also used a lot by financial analysts since some factors can affect how models are built and how money is spent.
Key points from a PESTEL analysis can be used in other frameworks for industries and companies, like Ansoff’s Matrix, Porter’s 5 Forces, and SWOT Analysis.
In a broad sense, political factors are those that are affected by what the government does and how it runs. They include things like, but are not limited to:
- Taxes on businesses
- Other ways to deal with money
- Free trade disputes
- Antitrust and other issues that hurt competition
It’s important to remember that even the possibility of trade disputes or antitrust issues can present management teams with important risks and opportunities.
When left- and right-wing parties have different views on key platform issues, it can be hard for a company’s management team to predict what will happen after an election. This is because the outcomes can be very different depending on who wins.
Economic factors have to do with the whole economy and are usually about money. Among them are:
- Rates of interest
- Employment rates
- Rates of exchange
Many analysts in the financial services industry put more weight on economic factors than on some of the other factors in this framework. This is because economic factors are easier to measure and model (which are somewhat qualitative).
Most of the time, it’s harder to measure social factors than it is to measure economic ones. They refer to changes or improvements in how people live and spend their free time, which can affect business. Here are some examples of social factors:
- Think about the number of people.
- Lifestyle trends
- Consumer beliefs
- How people feel about working conditions
Compared to things like interest rates or taxes on corporations, social factors may seem like less important things to think about. Still, they can have a shockingly big effect on whole industries.
Think about how the trend toward healthier and more active lifestyles has led to the development of connected fitness technologies and a lot of changes in the food we eat and how it is packaged and sold.
Technology is used everywhere in business today, and it changes quickly. Analysts and management teams must both know how technological factors can affect a business or an industry. Some of them are, but not all of them are:
- How research and development (R&D) can affect both costs and a company’s ability to compete
- Infrastructure for technology (like 5G, IoT, etc.)
- Internet safety
In today’s business world, technology is changing things at a speed and on a scale that has never been seen before. This has had a devastating effect on many traditional businesses and industries, like how Uber changed the transportation industry or how e-commerce changed retail as we know it.
Environmental factors were added to the original PEST framework because it made sense to do so as the business world began to realize that changes in our physical environment can present organizations with important risks and opportunities. Examples of environmental considerations are:
- Footprint in carbon
- Effects of climate change, such as physical and transition risks
- More extreme weather events are happening.
- Taking care of nature’s resources (like fresh water)
Most of the environmental factors found in an ESG (Environment, Social, and Governance) analysis will also be found in a PESTEL analysis. Many people think that the rise of CSR (Corporate Social Responsibility) and ESG (Environmental, Social, and Governance) led to the addition of environmental factors to the PESTEL framework.
Legal factors are those that come up because of changes in the regulatory environment. These changes can affect the economy as a whole, certain industries, or even just one business in a sector. Some of them are, but not all of them are:
- Regulation of business
- You need licenses and permits to run a business.
- Laws about jobs and protecting consumers
- Taking care of IP (Intellectual Property)
Operators can be helped or hurt by rules and regulations. Increased capital requirements for financial institutions could be an example of a headwind. On the other hand, if regulations are so strict in a certain industry (let’s say food production), they could act as a moat to protect established operators and keep newcomers out.
PESTEL and Financial Analysis
When put together, the above six factors can have a big effect on firms’ risks and opportunities. Analysts have to be aware of these and try to figure out how to measure them in their financial models and risk assessment tools.
Some examples include:
- Based on what they think will happen with inflation, financial analysts may change model assumptions like revenue growth rates and gross margins.
- If a business hasn’t done a good job of managing its carbon footprint, it may have to pay fines or a carbon tax in the future. Analysts may want to plan for this by setting aside cash.
- When figuring out a company’s debt service coverage ratio, analysts at credit rating agencies may need to add a higher interest rate buffer for sensitivity analysis if the macroeconomic environment is changing.
- Massive levels of automation in a certain industry are expected to cut labor costs by X%, which would make a big difference in a financial model’s estimates of free cash flow.