PEST Analysis – The Way To Understand The Wider Environment

by Paul Simister on September 14, 2011

I’ve mentioned PEST analysis several times in passing in this blog so it’s probably about time I explained more about the importance of understanding changes in the wider economic environment.

What is PEST Analysis?

PEST stands for:

  • Political changes
  • Economic changes
  • Social & Demographic changes
  • Technological changes

It is a very easy acronym to remember when you want to look at how the wider strategic environmental factors are changing within which a particular business operates.

While PEST analysis is intended as a forward looking technique, I find it easiest to look back to look forward. Asking a management team what could change over the next three to five years that we need to consider when building our strategy is much easier when you’ve taken 15 to 30 minutes to look back over the last five years to see how the business has been buffeted by environmental change – some good, some bad.

Alternative Versions Of PEST Analysis

You find find when you’re reading books on strategy or you’re talking to a strategy consultant that they use a slightly different acronym for the same basic concept.

Let’s take a look at a few of the popular ones:

  • STEP analysis – the same PEST factors in a different order
  • SLEPT analysis – the PEST analysis with legal issues separated from the political factors
  • PESTLE, PESTEL or PESTER analysis – legal (or regulation change) plus environmental (or ecological) changes are added. I tend to use PESTER in my own strategy work because it’s the one I learnt in my MBA training.
  • STEEPLE – is PEST with legal, ecological and ethical issues added.
  • STEEPLED analysis – is STEEPLE with demographics pulled out of the social changes.

One interesting variation is to add in a location factor into your PEST analysis for local, national and global issues, potentially creating LoNGPESTEL or equivalents.

Sorry if all the anagrams make your head spin. It is the same basic PEST concept with some factors having more emphasis.

PEST can include all the other factors so you may want to stick with the basic main four unless you want to give particular emphasis to one or more of the extra factors. For example if you work in the oil industry, you’d separate out ecological issues to give them extra focus because of the economic and reputational damage if things do go wrong. If you work for a drug company, then you’d track regulation changes in the different territories very carefully.

Perceptions Of The External Environment

The external environment is very complex and continually evolving. We each perceive our environment rather than have clear knowledge of it.

This means that there is are differences between:

  • Perceptions of one member of the management team and another
  • Perceptions between one business and its competitors
  • The perceived environment and the real environment

Techniques like PEST Analysis and the Five Forces Analysis help to close the gap between the perceived environment and the real environment and between members of the strategy team.

Understanding the current external environment is the gateway to having insights about the future environment.

The Purpose Of PEST Analysis

Businesses are not in full control of the factors which influence their profitability and success and PEST analysis is a technique to identify changes in these underlying factors within the foreseeable future.

  • To identify changes that can create opportunities for the business.
  • To identify changes that may be threats which the company needs to take action to defend against or to monitor carefully.
  • To provide a basis for assessing the risks that the business will face in implementing its strategy.

Here is a little reminder about the importance of understanding the external environment your business operates within.

In the struggle for survival, the fittest win out at the expense of their rivals because they succeed in adapting themselves best to their environment. Charles Darwin

What’s true in nature is also true in business. If you overlook the external environment as defined through PEST analysis, you are gambling with the future of your business.

PEST Analysis And The Link To SWOT Analysis

PEST Analysis is often a major contributor to SWOT analysis.

If you’re thinking that PEST analysis and SWOT analysis are very similar, then it will help to think that PEST applies to the primarily to the market (you, your customers and your competitors). If you and your competitors both do PEST, the results will probably be very similar if you have the same ability and commitment to the process.

In contrast SWOT is unique to the business and your SWOT analysis is likely to be very different from your competitors (if differentiated or if you want to be differentiated).

How To Do A PEST Analysis

    1. Assemble your strategic planning team
    2. Agree on the purpose of the exercise and the time horizon
    3. Agree whether you’re doing PEST, STEEP, PESTER etc
    4. It can be helpful to go back as a group and see what changes have occurred over the last few years to show that things continually change in the external environment. Many people say change is speeding up so I recommend you look back further than you look forward. For example, if you want to understand what might happen in the next two to three years, I’d look back over the last five years.
    5. Spend 15 to 20 minutes to collect your individual thoughts on how the PEST factors will affect the market – your business (and your employees and suppliers), your customers and non-customers (and their customers) and your competitors (and their employees and suppliers). It can be helpful to go back and see what changes have occurred over the last few years to show that things continually change. Identify both trends and significant events.
    6. Record what you know/believe/suspect and also any things that you’ve realised that you don’t know but should.
    7. Share ideas from each member of the strategy planning team to create a master list of PEST factors
    8. Discuss and build a shared view – rate each for its probability and potential impact
    9. Research any missing areas of knowledge
    10. Refine and identify the major issues which need to be carried into your SWOT analysis and built into your strategic analysis.
    11. Develop a monitoring system to keep the management team up-to-date with changes in the PEST factors on a regular basis. PEST analysis can be hard to do well when you first do it because you don’t know what you don’t know but over time you’ll have a much better understanding of how your business fits into the wider environment.

Focus Your PEST Analysis Thinking

I find it helpful to focus PEST analysis on:

  • Demand and the distribution channels
  • Costs and the ability to operate
  • Competitors – for example if you compete internationally it’s easy to see winners and losers as exchange rates shift

PEST Analysis And Porter’s Five Forces

PEST analysis is a useful way to add an element of dynamics to Michael Porter‘s famous Five Forces model of industry analysis.

You can think through how these wider environmental forces will impact on each force.

PEST Analysis & Michael Porter's Five Forces PEST Analysis can be used to look at each of Michael Porter’s five forces

The PEST Factors

I’m not going into much detail on the individual elements which can be included in the PEST analysis because I’m planning to write separate articles and I want to look deeply at certain issues.

Too often PEST analysis is done poorly but events over the last four years (since the credit crunch) have shown that the wider economic environment is not a benign place which lets a business do whatever it wants.

Political Factor Changes in PEST

  • Government spending – both the amount of spending and the priorities of the spending.
  • Taxation levels, incentives and punishments (e.g. punish the polluter)
  • Environmental legislation
  • Trade restrictions and relationships with the rest of the world
  • Political stability and confidence
  • Local, regional, national, international political issues

Economic Factor Changes in PEST

  • Position in the trade cycle or business cycle, expected GDP growth, leading or lagging product, necessity or discretionary purchase
  • Inflation
  • Interest rates
  • Exchange rates
  • Employment levels and the misery index.

Social Factor Changes in PEST

  • Demographics – age, sex, family structures, occupations
  • Religious beliefs
  • Social beliefs and norms of behaviour
  • Lifestyle

Technological Factor Changes in PEST

  • Cutting edge research findings
  • Technology in the product including material technology
  • Technology in the production process and energy technology
  • Information technology and its impact on access to reliable information
  • Technology transfer issues

PEST Uncertainty & Scenario Planning

Inevitably when you look into the future, you are having to face up to uncertainty.

You don’t know:

  • What will happen?
  • When it will happen?
  • How much will change?

The idea of PEST analysis is to anticipate what you expect to happen because history and common sense shows that things won’t stay the same. The world changes, whether you are ready or not.

An advanced form of future thinking based on PEST Analysis and other predictive techniques is scenario planning.  This is particularly appropriate when there is major change that may or may not happen (e.g. the collapse of the Euro currency zone).

PEST Analysis Is Key To Sustaining Competitive Advantage

If your business is successful, it’s very easy to become complacent and believe that the key success factors that are working so well today, will continue to do so tomorrow, next month and next year.

PEST Analysis gives the strategist the ammunition to challenge the existing strategy whilst it is still working and that gives the business time to make the changes ahead of the market and even influence it in the right direction.

Summary Of PEST Analysis

Keep focused on how changes in the PEST factors will impact on the six step profit formula.

There are three elements to PEST strategy:

  1. What do you think will change in the wider economic environment?
  2. How do you think those changes will impact on the business, on customers and their wants, needs and ability to pay and on competitors and your relative competitiveness?
  3. What can you do to take advantage of the opportunities and protect yourself from the threats identified from your PEST analysis.

Too often, PEST analysis is done as a form filling exercise to keep the strategy facilitator happy. Events from 2007 onwards with the credit crunch, the recession and the public sector debt crisis highlight the change from a benign to an oppressive economic environment.

The book, The Well Timed Strategy by Peter Navarro looks at managing across the economic cycle and how the same decisions at one stage of the economic cycle are very sensible but at another, very damaging.

What Are Your Experiences Of Using PEST Analysis?

Do you find PEST analysis a useful technique?

If so, do you have any particular tips to share?

If not, why do you think your experience of PEST hasn’t provided valuable insight?

Paul Simister is a business strategy coach who helps business owners to differentiate their businesses and develop winning strategies. Get your free copy of the ebook The Six Steps Profit Formula.

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{ 1 comment… read it below or add one }

Jerome David February 22, 2012 at 11:14 pm

awesome very helpful. Thank you


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