PEST Analysis: What It Is, How to Conduct It, and Why
PEST analysis is a powerful tool for developing business strategy. It considers the impact of the external environment on a company, analyzing the political situation, economic conditions, social and cultural trends, and the rapid development of technologies.
Toy store analysis template from visual-paradigm.com
Who invented PEST analysis
This method was first proposed by Harvard University professor F. Aguilar in the distant 1960s. Initially, it was called ETPS (Environment, Technology, Politics, Society), but was later renamed PEST for convenience. Sometimes variants like "STEP analysis" are encountered; the essence remains the same.
PEST analysis is often used when launching new products into the market. It allows companies to look into the future for several years, assess potential risks, and identify promising growth directions.
What is considered in a PEST analysis
Let's take a closer look at what PEST analysis is and the factors it consists of.
PEST is a convenient acronym formed from the first letters of the English words:
Politics: government support, taxes, industry regulation.
Economics: exchange rates, inflation, growth or decline.
Society: birth rates, quality of life, demographic changes.
Technology: innovations, the emergence of competitors.
The success of any business depends on its ability to adapt to constantly changing external conditions. PEST analysis offers a structured approach to identifying key political, economic, socio-cultural, and technological factors that affect a company's operations. Let's examine each group in more detail.
Political factors
Foreign policy: How the country interacts with others on the world stage, be it cooperation, conflicts, or trade agreements.
Domestic policy: Taxes, laws, and government influence on specific sectors.
Support: Availability of benefits, subsidies, or other forms of government assistance.
For a deeper analysis, ask yourself the following questions:
How will changes in government policy impact my industry?
What are the potential consequences of new trade agreements for my business?
How will changes in the tax code affect my company's financial situation?
Economic Factors
Inflation and GDP:
Increases in the cost of materials, labor, and other resources will lead to higher expenses and reduced profits.
GDP growth will increase demand for goods and services, boosting revenue.
Interest rates and currency:
Rising interest rates will make loans more expensive, negatively affecting investment and income.
Currency fluctuations will make exports more (or less) attractive and impact the cost of imported goods.
Income and unemployment:
Rising unemployment leads to social tension.
A decrease in purchasing power will reduce demand.
Adjacent markets and competition:
Increased competition will lead to lower prices and profits.
Growth in adjacent markets increases demand for your goods and services. A decline has the opposite effect. For example, if the smartphone market grows, as a case seller, you will benefit.
Questions for analyzing these factors:
How will inflation impact my company's production costs?
How will fluctuations in GDP growth affect my sales performance?
How will the unemployment rate affect my ability to attract and retain talented employees?
Socio-cultural factors
Customs and living standards influence the types of goods and services people value and are willing to spend money on. For instance, a growing middle class will create opportunities for premium segment products.
Changes in birth rates, mortality rates, and age structure affect the size and purchasing power of different demographic groups. For example, an aging population will increase demand for healthcare services.
The level of education of the population affects how people perceive information and make purchasing decisions.
Growing concerns about environmental issues will increase demand for "green" products and services. Companies that demonstrate social responsibility will attract more loyal customers.
Social networks influence how people learn about brands and make purchases.
Questions for analyzing these factors:
How do demographic shifts affect my target market?
How do consumer preferences change the demand for my products or services?
How will rising education levels impact the skills and expectations of my workforce?
Technological factors
New technologies:
Study innovations that automate, improve, or change your products, services, or business processes.
Assess how these innovations will affect your competitiveness, efficiency, and growth opportunities.
Legislation:
- Understand the laws that protect your innovations and stay updated on changes.
Industry impact:
Analyze how various innovations are changing your industry and adapt your strategy to new realities.
Use technologies to create products, services, or business models.
Competition:
- Monitor the developments your competitors are investing in.
Questions for analyzing these factors:
How are new technologies changing the operations of my industry?
How can I use innovations to improve my products and processes?
How can I protect my intellectual property from competitors?
How PEST analysis differs from SWOT analysis
PEST and SWOT are two popular strategic analysis tools that may seem similar at first glance. However, it's important to understand that these methods are not interchangeable but complement each other.
PEST focuses exclusively on factors outside the company's control. It helps to:
Identify various external factors that impact the business.
Anticipate possible scenarios and their effects on the company.
Develop strategies to respond to external threats.
SWOT analysis has a broader scope and considers both internal and external elements.
STEP analysis serves as a foundation for SWOT.
PEST analysis: Identifying external factors.
SWOT analysis: Assessing the impact of these factors on the company's strengths and weaknesses.
Use SWOT analysis to:
Compare yourself with competitors.
Evaluate your strengths and weaknesses.
Develop a strategy to leverage your advantages and neutralize weaknesses.
Goals of PEST analysis
Let's take a closer look at why and how often to conduct the analysis.
Main goals of PEST analysis are:
Defining a long-term strategy: PEST analysis helps in forecasting changes for several years ahead. This allows you to develop a sustainable growth strategy.
Risk assessment: It identifies potential threats such as changes in legislation, economic crises, or new technologies. This helps in minimizing possible losses.
Understanding the business environment: PEST analysis provides an objective picture of the external environment, which is especially important when entering new markets.
Take into consideration:
PEST analysis is recommended to be conducted annually to adjust the strategy considering changes in the macro environment.
Use PEST in conjunction with other strategic planning tools, such as SWOT or brand tracking.
For small startups, frequent PEST analysis is not necessary.
PEST or PESTLE?
Sometimes, an extended version called PESTLE analysis is used, which additionally considers the influence of Legal and Environmental factors.
Environmental factors: Monitor trends in environmental policy, standards, and public sentiment that can affect business in the near future. This is relevant for certain industries.
Legal factors: Keep track of regulations and legal requirements.
How to conduct a PEST analysis
It's convenient to perform the analysis in Google Sheets. Download a template and fill it with data: analyze the political, economic, social, and technological factors (as well as legal and environmental factors if relevant), assess their impact on your business, and formulate conclusions and recommendations. Use PEST for strategy development, decision-making, marketing planning, and risk assessment. Regularly update the analysis—at least once a year.
Template from smartsheet.com in Google Sheets
Here are the steps of a PEST analysis:
1. Determine what is important for your company
Identify the factors that affect the organization’s operations and revenue.
Create a list of these components. Each company will have its own list.
2. Gather the necessary information
Use various sources:
Research.
Books.
Media.
3. Evaluate how these factors impact your company
Use a scale from one to three:
1 - The impact on the company's operations is minimal.
2 - The factor is significant for the company but its influence is not critical.
3 - The factor has a substantial impact on the organization.
4. Determine the likelihood of changes
Use a scale from one to five. For example, evaluating the unemployment rate:
1: Will remain unchanged.
2: There is a chance of changes.
3: Will slightly increase.
4: Will significantly increase.
5: Will rapidly increase.
5. Assess potential changes
Use the following formula to calculate the weight, which determines how significant the factor is.
There are other formulas as well. For example, calculate the arithmetic mean of the likelihood of changes and then add the impact assessment from the corresponding column. The larger this number, the more important the factor.
6. Create a matrix
Arrange the factors from highest to lowest.
The higher the score, the more thoroughly it needs to be studied.
7. Identify challenges and how to address them
Delve deeper into the most important factors.
Formulate steps that can mitigate adverse impacts.
8. Continue monitoring
- Constantly monitor particularly significant components.
Conclusion
PEST analysis is your key to understanding the complex external environment. With it, you will grasp the political landscape, economic trends, social changes, and technological advancements.
Monitor how the current situation affects your business—look for both opportunities and risks. Regular PEST analysis will help your company remain agile and stay ahead of the competition.