Analyse the outside forces acting on an industry with the PESTLE framework
The idea
Industry analysis starts outside the company. Porter's Five Forces explains profitability through competitive pressure: rivalry among existing firms, the threat of new entrants, the threat of substitutes, and the bargaining power of suppliers and of buyers. The more these forces are held in check, by barriers to entry, differentiated products or fragmented customers, the higher the returns an industry can sustain. PESTLE covers the wider environment: political, economic, social, technological, legal and environmental influences, such as regulation, the business cycle, demographics, new technology and carbon policy. The aim is not a checklist but to identify which few external factors will actually drive demand, costs and competition over the forecast horizon.
A practice question
Grocery retailers adopting automated self-service checkouts would be classified in a PESTLE analysis as a:
- technological factor - correct
- legal factorWhy not: Legal factors concern laws and regulation; adopting a new process technology is not a legal change.
- environmental factorWhy not: Environmental factors cover climate, resources and pollution, not changes in how stores operate.
New technologies that change production, distribution or customer interaction belong to the technological element of PESTLE.
A harder one
A sharp rise in interest rates that increases the cost of mortgages and so reduces demand for new homes is, for house builders, best described as a PESTLE:
- political factorWhy not: Assumes interest rates are government policy; in PESTLE they are grouped with other macroeconomic conditions.
- social factorWhy not: Treats the fall in demand as a change in attitudes, when it is driven by financing costs.
- economic factor - correct
Interest rates, inflation, exchange rates and economic growth are economic factors, which affect industry demand and cost of capital.
The hardest tier
For an agri-food company, a data-analytics firm and a car maker respectively, a drought that cuts crop yields, a new data-protection law and a government subsidy for electric vehicles are best classified in a PESTLE analysis as:
- environmental, technological and economicWhy not: Classified the data law by the industry it affects rather than by its source; a statute is a legal factor, and a subsidy is a policy choice.
- environmental, legal and political - correct
- economic, legal and socialWhy not: Classified the drought by its consequence for profits; its source is the physical environment, which is what the E in PESTLE captures.
PESTLE sorts external influences by their source. Weather and climate are environmental; binding rules such as a data-protection statute are legal; a government's decision to subsidise a technology is a political (policy) choice, even though its effect on demand is economic.
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