What Is a PEST Analysis?

What is a PEST analysis?

A PEST analysis is an assessment of the political, economic, social and technological factors that could affect a business now and in the future. The purpose of a PEST analysis is to help a company’s management team better understand the market they’re operating in now and how they can prepare for potential shifts (for example, regulatory changes).

Elements of a PEST analysis

A PEST analysis covers four elements: political, economic, social and technological factors.

Political environment

The “P” in PEST refers to the political factors that help or hinder a business. 

“We see this currently in the U.S., particularly in the area of international business,” said Donna Lubrano, a lecturer in the Northeastern University College of Professional Studies. “We look at tariffs, trade deals as they are developed not only by the economics or business side but what political relationships influence those decisions.”

A PEST analysis examines the following political factors:

• Employment regulations: Will it become more expensive to employ staff because of minimum wage laws, safety-at-work legislation, pension contributions, healthcare contributions and so on? Are tax authorities classifying more contractors as employees?
• Environment: Can profit levels be maintained if authorities demand a less-polluting production process or if they levy a charge on companies in your sector for post-use cleanup of your products?
• Government policy: Are laws a government passes in general conducive to businesses, specifically your business?
• Intellectual property protection: Do the laws and court system in a country recognize the rights of intellectual property (IP) holders? In addition, how hard is it to seek redress against IP and copyright theft?
• Property rights: Do you have sufficient rights to protect and exploit resources and your assets?
• Stability: Unstable political environments, particularly countries with regular (and often forced) changes of government, make planning difficult. In more stable countries, will a particular party coming to power materially affect your business and its profitability?
• Tariffs: If you import materials for production and/or export finished products to customers, how will any tariffs affect areas of your international business, such as the cost of production and pricing competitiveness?
• Taxation: What does the tax policy of the current government mean for your business’s cash flow, tax deductions and profit margins? [See our list of small business tax deductions.]
  
• Trade restrictions: Are there sanctions (or likely sanctions) against doing business with a country you’re targeting?

Economic conditions

The “E” in PEST refers to the outside economic issues that can play a role in a company’s success. 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,” Lubrano said. Also look at interest rates, exchange inflation, unemployment, gross domestic product, credit availability, and the rise and fall of the middle class. 

A PEST analysis examines the following economic factors:

• Access to credit: For higher-ticket products and services, can consumers or business customers get ready access to competitively priced credit to purchase from your company?
• Business investment levels: Do companies in your target market regularly replace their machinery and equipment, or do they try to make them last as long as possible?
• Cost of living: Higher prices affect business competitiveness because of increased housing costs and the need to pay staff more to mitigate those costs.
• Economic growth or decline: If an economy is improving, consumers and businesses are likely to have more cash to purchase products or services. Economic growth triggers higher levels of investment by businesses in general.
• Exchange rates and interest rates: Countries with a more robust economy suffer less from fluctuations in currency values (which is important if you import or export products). In addition, these countries are more likely to have higher interest rates that dampen local inflation (although this has not always been the case since the Great Recession of 2008-2009).
• Globalization: Globalized countries in which tariffs and restrictions have (largely) been removed enjoy faster economic growth and improved socioeconomic conditions for customers and staff.
• Inflation: Higher levels of inflation erode the value of money faster. In some cases, businesses may not be keen to pass on higher costs to customers, so profits fall.
• Labor costs and workforce skill levels: A shortage of workers with the skills required to perform a role will lead to rising labor costs that will hurt profitability. Sometimes, a shortage may be severe enough to require companies to spend more on training.
• Market conditions: How fast is a market growing? How big is the total market? How many competitors are in this market, and how does this affect pricing and costs?
• Spending habits: Are the consumers or businesses you are targeting spending more money on your products and services? Are they spending a different way (for example, moving from real-world to online spending)?
• Tax levels: Given the choice between two states or countries where almost every other PEST consideration is equal, a company may be more likely to target lower-tax countries first for investment.

Social considerations

The “S” in PEST relates to the socioeconomic environment of a given industry’s market for a business to understand how consumer needs are shaped and what brings them to the market for a purchase. 

“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.”

A PEST analysis examines these social factors:

• Attitude toward work (productivity): The more productive a workforce is, the more competitively the company can price its products or services or increase profit margins. [Learn how to calculate profit margins.]
• Consumer trends/tastes/fashions: There is often a substantial gap in time between the creation of a product and its launch, so tracking trends, tastes and fashions is important to ensuring the success of any new product.
• Diversity, inclusion and equality: It’s increasingly important to Gen Z and millennials that their brands of choice support their values. Should you launch a corporate social responsibility program and a diversity, equity and inclusion policy? [Learn how to create a diversity and inclusion training program.]
• Division of wealth: Economic inequality has a negative impact on organizational performance, a 2015 study in the journal Human Relations found. It also affects growth in consumption rates during periods of economic decline.
• Education: The quality of education varies among states and countries; lower levels of education require a greater investment in staff training. Lower levels of education are normally matched by lower levels of pay.
• Employment patterns and job market trends: There has been a shift toward part-time work and self-employment in many states and countries, making it harder to recruit. In addition, the type of staff you wish to recruit may be in particular demand, leading to higher employment costs.
• Generational attitude shifts: Expectations from an employer may differ among generations, necessitating a change in the way employees are rewarded, targeted and remunerated. [Wondering what kinds of rewards to offer? These workplace incentives will boost employee morale.]
• Health of the population: Many companies now invest in the mental and physical well-being of their staff to reduce absenteeism and to improve productivity.
• Population demographics: Does a state or a market contain the types of staff and customers you are looking for in relative abundance?
• Population growth rate: States or countries whose population is growing primarily through immigration may experience slower growth in pay rates as a result of increased competition.
• Social mobility: States or countries with a larger middle class that are easier to enter often have higher rates of economic growth and lower rates of income inequality.
• Unionization: Many employers believe that more highly unionized workforces cost more and are less flexible, although this is disputed.

Technological landscape

Technology plays a huge part in business and can have both positive and negative effects. Some businesses may have a difficult time adjusting to new products, technologies and services, so it’s important to assess the technology from all angles.

A PEST analysis examines these technological factors:

• Artificial intelligence (AI): A company may be able to optimize efficiency and productivity through investment in AI. [See how artificial intelligence will transform businesses.]
• Automation and robotics: Many sectors now automate as many of their processes as possible to use raw materials more efficiently, offer better service to clients and manufacture more products at a cheaper cost per unit.
• Cybersecurity and data protection: Cyberattacks continue to affect businesses, so companies should collect only the data they need for operation and should protect that data robustly. [Want to learn more about how to protect your business’s data? Check out our cybersecurity guide.]
• Disruptive technologies: Disruptive technologies, like smartphone apps, may open a company to new markets, particularly in the financial sector.
• Innovation: Given the accelerated rate of technological innovation affecting many sectors, should you invest in innovation now to stay ahead of the curve, or react to the innovations of competitors?
• Remote work: Do the existing technology and infrastructure allow staff to work remotely? [Check out the best remote working tools to help your team stay connected.]
• Research and development: Should a company invest in R&D in jurisdictions where significant tax breaks are offered for this type of work?
• Social networking: Should your company invest in social networks for promoting its products and services and to hire staff? And should you invest in apps like Slack and Asana to enable smoother communication among employees in different locations?
• Tech hubs: Should the company (or part of the company) relocate to a tech hub where technological innovation is more likely because of the availability of staff, investors, suppliers, educational establishments and service providers?

How to conduct a PEST analysis

Now that you know what a PEST analysis is, it’s time to gather the data. Follow these steps to conduct a PEST analysis:

1. Identify the political factors.

Conduct internal research to identify what types of laws or policies affect you. These factors may include the following:

• Material or product sourcing (import quotas, tariffs, price supports and subsidies, and preferences)
• Human resources (visas, EEOC requirements, vaccine requirements)
• 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)

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 affect your business. For example, consider the following:

• 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 business-to-business (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 affect 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.

4. Identify the technological factors.

This is particularly important if you are in a tech industry such as software, but technological factors affect every industry in some way. Read industry publications and do a competitive analysis 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

Benefits of a PEST analysis

Many of the issues considered in a SWOT analysis can be influenced or shaped by your company and its decisions. In a PEST analysis, however, the focus is exclusively on external factors, such as current and future regulations, taxes, political issues, environmental legislation, and employment laws. 

The benefits of performing a PEST analysis include the following:

• 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. 
• 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 either deal with them or prevent them altogether. Proactively implement policies to gain a competitive edge, devote resources to influencing laws that may potentially hurt your business or make strategic alliances that give you a stronger market position.
• Insight into 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.

When it’s done right, a PEST analysis gives your company the ability to successfully navigate changes in the world around it. As well as alerting you to potential threats, it can signal brand-new opportunities to expand into different markets and territories. 

In some cases, a PEST analysis may cause a company to shift some of its operations from one country to another, as many U.S. automobile manufacturers have done.

PEST analysis disadvantages and limitations

Although there are many potential benefits of a PEST analysis, it can have limitations as well. Consider the following drawbacks:

• Ever-changing environments: Because these environments are so dynamic, your analysis could be outdated within days or even hours. 
• A lot of guesswork: You’ll have to make assumptions about some factors, so there’s always a chance of miscalculation.
• Data overload: Because a PEST analysis involves such large data sets, it takes careful analysis to parse the data 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 percent accurate.

What is a PESTLE analysis?

A PESTLE analysis is similar to a PEST analysis, but it includes two more factors: legal and environmental. 

For the legal factor, a company should examine how legal changes and interpretations could affect a company, directly or indirectly, said Daniel Feiman, managing director at consulting and training firm Build It Backwards. He advised including changes in laws, global law conflicts and U.S. Supreme Court decisions in this portion of the analysis.

For the environmental portion of the analysis, Feiman said to examine how environmental regulations, such as laws regarding endangered species, could affect the business. 

Feiman also suggested measuring each of the factors, including the original PEST factors, 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

Other types of business analyses

For a PEST analysis to be truly valuable, it should be used in conjunction with the following other analyses:

• SWOT (strengths, weaknesses, opportunities, threats) 
• MOST (mission, objective, strategies, tactics) 
• SCRS (strategy, current state, requirements, solution)

Business analyses help you strategize and plan

Conducting critical business analyses like PEST and others allows you to better understand the circumstances surrounding your business. When you clearly articulate those circumstances, you can better develop a strategy to navigate them successfully. Periodically take the time to put pen to paper and think through the external factors affecting your business and how you can turn them to your advantage. It may just provide the competitive edge your team needs to succeed. 

Jennifer Dublino and Jennifer Post contributed to this article. Source interviews were conducted for a previous version of this article.