- Researching trends and possibilities that may affect your business allows you to plan and act strategically.
- Tap into both internal expertise and outside sources for a comprehensive look at factors in each area.
- External factors can present your company with both threats and opportunities.
- This article is for business owners thinking of their success in the midterm and long term.
As an entrepreneur, you can try to predict how your products or services will resonate with the public. However, there will always be factors outside of your control affecting how your business operates. A PEST analysis is one method for discovering and quantifying those factors.
What is a PEST analysis?
"PEST" is an acronym for "political, economic, social and technological." It's a way of understanding how external forces impact your business. This concept was created by Harvard professor Francis Aguilar in 1967. It should be included in every business plan, in addition to a SWOT analysis, because it is an essential component of risk management and strategy design.
P – Political
According to Donna Lubrano, senior advisor at Northeastern University, the political environment is an analysis of what politics is doing to the business world.
"We see this currently in the United States, particularly in the area of international business," she said. "We look at tariffs and trade deals as they are developed not only by the economics or business side, but what political relationships influence those decisions."
Government regulations and legal issues affect a company's ability to be profitable and successful, and the political environment factor looks at how that can happen. Issues such as tax guidelines, copyright and property law enforcement, political stability, trade regulations, social and environmental policy, employment laws, and safety regulations should all be considered. Companies should also weigh their local and federal power structure and discuss how anticipated shifts in power could affect their business.
E – Economic
The economic factor examines outside economic issues that play a role in a company's success. Look at interest rates, exchange inflation, unemployment, gross domestic product, credit availability and rise and fall of the middle class. Lubrano noted it's important to look at what the Fed is doing in terms of the tax rate, as "this is what your pocketbook/wallet lives on every day."
S – Social
Analyze the socioeconomic environment of the given industry's market to understand how consumer needs are shaped and what brings them to the market for a purchase. Examine demographics, population growth rates, age distribution, attitudes toward work and job market trends.
"We look at what changes in culture and society are taking place," Lubrano said. "The drive to eat healthier, the drive to care for the environment, baby boomers staying in the workforce longer, adults having fewer children later in life – all of these impact how consumers buy houses, cars, etc."
T – Technological
Technology plays a huge part in business. With the introduction of new products, new technologies and new services, your marketplace could have a tough time adjusting, so it's important to assess technology from all angles.
Specific items to scrutinize include, but are not limited to: government spending on technological research, the life cycle of current technology, the role of the internet and how any changes to it may play out, and the impact of potential information technology changes.
A similar analysis, PESTLE, includes two more factors: Legal and Environmental (or Ethics). For the legal factor, you should examine how legal changes and interpretations could directly or indirectly impact your company, according to Daniel Feiman, managing director of consulting firm Build It Backwards. He advised including changes in laws, global law conflicts and Supreme Court decisions in this portion of the analysis.
For the environmental portion of the analysis, Feiman said to look at environmental evolutions and regulations to determine how they could impact a business. Look closely at ecological regulations and restrictions as well as endangered species.
How to conduct a PEST analysis
Now that you know what a PEST analysis is, it is time to gather the data.
1. Identify the political factors.
Conduct internal research to identify what types of laws or policies impact you, such as the below:
- Material or product sourcing (import quotas, tariffs, price supports and subsidies, and preferences)
- Human resources (visas, EEOC requirements, vaccine requirements, etc.)
- Manufacturing/operations (OSHA requirements)
- Accounting and finance (IRS requirements, tax hikes, breaks and deductions, and SEC reporting requirements)
- Marketing and customer demand (online business law requirements, the CAN-SPAM Act, etc.)
Talk to your lawyer or legal department or the people in charge of compliance, safety, reporting, finance, and accounting, each of whom should be familiar with current and proposed laws.
2. Identify the economic factors.
Determine which economic factors will impact your business and research online to see where these factors are now and where top economists are predicting they will be in the future. Talk to your internal managers to see if they are experiencing or anticipating any issues in their areas. The economic factors that affect you depend on the type of business and customer you have.
- If you sell consumer goods and services, look at the consumer price index, inflation, employment, consumer confidence, disposable income and wages.
- If you sell high-ticket items that require financing, look at interest rates.
- If you sell B2B services such as marketing or consulting, look at unemployment and other recession measures.
- If you sell or buy products as components, look at supply chain issues and tariffs.
- If you employ relatively low-wage workers, look at salaries and employment to see if you will need to raise wages to attract talent.
3. Identify the social factors.
If you have done market research on customer or target market perceptions and demographics, this step is at least partially done. It's also a good idea to read industry publications, which frequently highlight social factors that impact the industry as a whole. Talk to your customer service and sales staff to get feedback from customers on why they buy and why they return or cancel. If you have a local business, periodically conduct an area market analysis to understand your potential customers.
FYI: The Pew Research Center is a useful (and free) source of social and demographic trend research.
4. Identify the technological factors.
This is particularly important if you are in a tech industry such as software, but it impacts every industry in some way. Read industry publications and research competitors to stay informed about new technology and innovative ways of using it to deliver products and services in your field. Look for the following updates:
- New programming languages and methods that will make your product or service faster, more accurate, or more detailed
- New apps that deliver your products or services in different ways
- New technology or processes you can use to make your products stronger, "smarter," cheaper, more convenient or readily available
Feiman also suggested evaluating each factor against the following grid.
- Potential impact: Low, medium or high
- Time frame: Immediate, short term or long term
- Type: Positive or negative
- Direction of impact: Increasing or decreasing
- Relative importance: High, medium or low
Tip: Look at the top emerging technologies such as electric vehicles, artificial intelligence, and virtual and augmented reality to analyze how they could hurt or benefit your business.
5. Determine necessary action.
Once you have evaluated each factor against the grid, you and your team should determine if you need to take action in any of the areas. Here are some examples of actions you might need to take.
- Lobbying against or for specific proposed laws and regulations
- Bringing operations into compliance with new laws and regulations
- Changing suppliers
- Offering promotions and discounts
- Raising prices
- Bundling products and services to offer more value
- Increasing wages
- Adjusting marketing message
- Appealing to a different target market
- Changing distribution (for example, adding curbside pickup)
- Creating an app for your customers to use
- Revising your software or digital marketing
- Retooling your factory
Benefits of a PEST analysis
There are numerous benefits of conducting a PEST analysis that can reap dividends for your business.
A greater understanding of your company
No company is an island; each business is intricately connected to its customers and society. By understanding the factors that have a positive or negative effect on your business success, you can get a sense of how your business can make a difference in other people's lives. This confers a stronger sense of purpose.
More effective long-term strategic planning
Conducting a PEST analysis every year informs your decisions for the future and prevents you from being caught by surprise. You have the opportunity to prepare for changes in the market and society in general. This will save you money, prevent lost revenue, and position you well against competitors.
Heightened attention to potential threats and dangers
When you are aware of potential threats, you can do something about them either to deal with them, avoid them or prevent them altogether. Proactively implement policies to gain a competitive edge, devote resources toward influencing laws that may potentially hurt you, or make strategic alliances that give you a stronger market position.
Insight for valuable business opportunities
Be the first in your field to take advantage of beneficial government policies or market opportunities. By keeping your finger on the pulse of the market, you can be in the right place with the right message. Bolster your company's reputation and goodwill by instituting policies that are viewed as ethical and responsible.
Limitations of a PEST analysis
There are a few disadvantages of doing a PEST analysis as well.
- Ever-changing environments: Because all of these environments are so dynamic, your analysis could be outdated within days or even hours.
- A lot of guesswork: You'll have to make a lot of assumptions on some factors, so there's always a chance of miscalculation.
- Data overload: Because a PEST analysis involves such large datasets, it takes careful analysis to parse it and decide how to use it to your advantage.
- Risk of inaccuracy: Most of the time, you'll be getting your information from outside sources, so you can't be certain it's 100% accurate.
For a PEST analysis to be truly valuable, it should be used in conjunction with SWOT (strengths, weaknesses, opportunities and threats), MOST (mission, objective, strategies and tactics) or SCRS (strategy, current state, requirements and solution) analyses.
Katherine Arline and Jennifer Dublino contributed to the writing and reporting in this article. Source interviews were conducted for a previous version of this article.