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PEST Analysis

The PEST analysis framework looks at how factors of change that are external to a business contribute to a business's overall risk. The factors looked at are external factors that lay outside of the control of the organization itself, broken into four categories: political, economic, social and technological. Because these factors affect the organization's risk, they are important to consider when evaluating the attractiveness of the industry the business operates in. Porter's five forces model also looks at the attractiveness of an industry (focusing more on an industry's potential profitability, rather than level of risk). As a result, a PEST analysis and Porter's five forces are often used in conjunction.

Political Change and Intervention: According to PWC, political risk involves "any political change that alters the expected outcome and value of a given economic action by changing the probability of achieving business objectives."1 While political decision making is fairly reliable in western countries, as the world becomes more globalized, businesses face increasing risks associated with political stability in developing and undemocratic countries. For example, what if your supply chain stems from a country whose leaders decide to go to war? That being said, political risk exists everywhere, even in the western world, in areas such as tax policy, labour law, environmental regulations, trade restrictions and tariffs.

Dependency on the Economic Cycle: Most businesses are dependent, in part, on the economic cycle. That means that during economic growth, businesses will do well, and in a recession, many businesses have a more difficult time. Some businesses experience the opposite. For example, in economics goods are classified as "inferior goods" if sales of these goods go up when purchasing power goes down. Staple foods like Kraft Dinner and hot dogs are inferior goods. If a family is concerned about its purchasing power today, or in the future, they are more likely to by Kraft Dinner, instead of steak, for the table - not good for the butcher! Government fiscal and economic policy also helps determine economic risk.

Social Demographic, Attitudinal, and Religious Change: Social risk factors include cultural factors and attitudes. For example, career attitudes about work-life balance are becoming increasingly relevant to businesses. Similarly, general attitudes, for example, about the acceptability of smoking have led to reduced smoking rates (and health side-effects) in adults. Social risk factors also include related demographic factors such as population age distribution and growth rate. For example, an aging western population is leading to a boom in the health care industry.

Technological Vulnerability: We live in a world of rapidly changing technology and resulting capabilities. Harnessing new technologies may give a firm a competitive advantage. At the same time, a failure to adopt a new technology may cause a business to fall behind its competitors.
A PEST analysis may also include legal and environmental factors (such as consumer protection laws or the affects of climate change).

 

Reference:

1. Eurasia Group and PricewaterhouseCoopers, “Integrating Political Risk Into Enterprise Risk Management”. Retrieved from http://www.pwc.com/Extweb/onlineforms.nsf/docid/F44B471C9D848314852570FF0069BBCA?opendocument

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