What is a PESTEL Analysis?
PESTEL Analysis is a strategic framework used to evaluate the external environment of a business by breaking down the opportunities and threats into Political, Economic, Social, Technological, Environmental, and Legal factors. PESTEL Analysis can be an effective framework to use in Corporate Strategy Planning and for identifying the pros and cons of a Business Strategy. This framework is an extension of the PEST strategic framework that includes additional assessment of the Environmental and Legal factors that can impact a business. Below we break down the key items of each of the 6 Factors of the PESTEL framework (Political, Economic, Social, Technological, Environmental, and Legal). Points derived from PESTEL Analysis can be incorporated into other strategic frameworks such as SWOT Analysis and Porter’s 5 Forces, where relevant.
When looking at political factors, you are looking at how government policy and actions intervene in the economy and other factors that can affect a business. These include the following:
One of the reasons that elections tend to be a period of uncertainty for a country, is that different political parties a have diverging views and strategies for policy on the items above.
Political Factor Example: A company decides to move their operations to a different state after a new government is elected on a campaign to implement policies that would adversely impact the company’s core operations.
Economic Factors take into account the various aspects of the economy, and how the outlook on each area could impact your business. These economic indicators are usually measured and reported by Central Banks and other Government Agencies.
Often these are the focus of external environment analysis. The Economic outlook is of extreme importance for a business, but the importance of the other PESTEL factors should not be overlooked.
Economic Factor Example: A company decides to refinance their debt after an interest rate decrease is announced.
PESTEL analysis also takes in consideration social factors, which are related to the cultural and demographic trends of society. Social norms and pressures are key to determining a society consumerist behavior. Factors to be considered are the following:
- Cultural Aspects & Perceptions
- Health Consciousness
- Populations Growth Rates
- Age Distribution
- Career Attitudes
Social Factors Example: The percentage of the American population that smokes has decreased since the 1970’s due to changes in society’s perception of health and wellness.
Technological Factors are linked to innovation in the industry, as well as innovation of the overall economy. Not being up to date to the latest trends of a particular industry can be extremely harmful to operations. Technological Factors include the following:
- R&D – Activity
- Technological Incentives
- The Rate of change in technology
Technological Factors Example: A company decides to digitize their physical data files to allow for quicker access to company information.
Environmental Factors concern the ecological impacts on business. As weather extremes become more common, businesses need to plan how to adapt to these changes. Key Environmental Factors include the following:
- Weather Conditions
- Climate Change
- Natural disasters (tsunami, tornadoes, etc.)
Additionally, there is increasing importance for businesses to be environmentally friendly with their operations, as evidenced by the rise Corporate Sustainability Responsibility (CSR) initiatives. Examples of CSR initiatives include carbon footprint reduction efforts and transitions into renewable material and energy sources.
Environmental Factors Example: An agricultural company has to adjust their harvest forecasts due to unexpectedly dry seasonal conditions that will prevent crop growth.
There is often uncertainty regarding the difference between Political and Legal Factors in the context of a PESTEL analysis. Legal Factors pertain to any legal forces that define what a business can or cannot do. Political Factors involve the relationship between business and the government. Political and Legal Factors can intercept when governmental bodies introduce legislature and policies that affect how businesses operate.
Legal factors include the following:
- Industry Regulation
- Licenses & Permits
- Labor Laws
- Intellectual Property
Legal Factors Example: A restaurant is forced to shutdown after not meeting food safety standards set out in state law.
PESTEL Analysis in Business Valuation
Combined, these six factors have a profound impact on the opportunities and threats for a business going forward. Before creating a business valuation model – such as a DCF Model – it’s important to understand how these factors will impact the company’s ability to generate cash flow.
Breaking down the external environment helps identify key elements to be incorporated into your business valuation. PESTEL Analysis is also useful for initial company screening, setting criteria that have to be fulfilled for analysis to be considered.
Learn more in CFI’s financial modeling courses.