1.5 – External Environment
PEST is an analytical tool for looking at the external environment of a business. It stands for Political, Economic, Social and Technological. There are also some variations of this, which will be looked at later. Other variations include PESTLE and STEEPLE, which add in Environmental, Legal and Ethical factors. PEST is useful for a business when creating a business plan or making another decision to get a quick, visual representation of their external pressures. It enables them to assess the various influences on them, include the actions of their competitors. This allows them to brainstorm effectively and make a thorough analysis of their opportunities. A PEST analysis looks at both the threats and opportunities for a business. It is best completed using the following steps: Brainstorm all the external factors affecting the business, placing them under the appropriate heading. Discuss which factors have the most significant impact on the business. Summarise the information.
These are changes in the government, regionally, nationally and internationally, which can have a huge effect on business activity. This can include public spending or international relations. The relationships a country has with others can either open or close markets to the business. These are closely linked with legal changes, such as consumer protection legislation, environmental legislation, workplace health and safety laws and employment laws. Political factors might include: The stability of the government Taxes Government spending Industrial policies International relations Employment and consumer laws Competition policy Environmental protection measures Foreign trade regulations [tariffs, embargos and quality control]
It is important to assess political factors at the regional, national and international level.
Political Opportunities and Threats
Government actions can control business behaviour and affect economic activity. Fiscal Policy This is when the government use taxes and expenditure policies to influence the economy. This can come in a number of forms: Direct Tax – Paid straight from the income, wealth or profit of individuals and businesses. Indirect Tax – Paid on the trade of goods and services Progressive Tax – When the amount of tax paid increases in proportion to rise in the income, wealth or profit of the taxpayer
Regressive Tax – When the taxpayer pays proportionally less tax as their income, profit or wealth rises. In this case, they are actually still paying the same amount of tax, but it is smaller in proportion to their income, etc. Proportional Tax – Taxpayers always pay the same percentage tax, regardless of their income, wealth or profits When the government increases its expenditure, this causes economic growth in the economy. When an economy has high rates of growth and inflation and needs to slow down, the government will use deflationary fiscal policy. However, if the economy is in a recession and needs boosting, the government may choose to use expansionary fiscal policy. Type of Tax Income Tax Corporation Tax Sales Tax Capital Gains Tax Inheritance Tax Excise Duties Customs Duties Stamp Duty Description A levy on personal income, which tends to rise as income rates rise. A tax on business profits. Small businesses tend to be charged a lower percentage. A levy on an individual’s expenditure A tax on the surplus made from investments in shares, property, etc. A levy on the value of assets passed on after the death on an individual Tax on demerit goods such as alcohol, tobacco, petrol, gambling, etc. Levy on foreign imports to give domestic suppliers price advantage and raise government revenue Tax on the purchase of commercial or residential property. The tax rate tends to increase as the value of the property increases.
Monetary Policy These policies control the amount of spending and investment in an economy, including interest rates. This affects the supply of money and interest rates. High interest rates attract foreign investors seeking better returns, which in turn affects the exchange rates. However, increasing interest rates will restrict spending and consumer confidence.
Governments tend to charge businesses varying levels of interest rates. This is due to: Risk – Interest rates tend to be higher when the risk of a business defaulting on a loan is higher. Time – Loans with a longer period will usually have higher interest rates Administration costs – When the costs of lending to a business are higher, the interest rates will be higher Expectations – When the economy is expected to do well, higher interest rates will dampen the effect of inflation
In any economy, there will be a series of fluctuations associated with general booms and slumps in economic activity. Business activity can be directly affected by this, as well as changes in the interest rates, minimum wage and inflation. Consumer activity, including confidence, spending patterns and willingness to spend will also be a major factor for business. Businesses will need to consider: Government fiscal policy Monetary policy Supply and demand side policies exchange rates Protectionist measures
Economical Opportunities and Threats
The four key objectives of governments are to control the rate of inflation, have high rates of employment, have good economic growth and improve the balance of payments. Controlled Rate of Inflation Inflation is the general rise in prices in the economy. For wealthy nations, this is ideally low and sustainable. Inflation is caused by: Demand Pull Inflation – this is when there is excessive aggregate demand, such as rise in consumption, investment, government spending or international trade earnings Cost Push Inflation – this is when rising production costs lead to a rise in prices to maintain profit margins. Such costs include wages, raw materials and rent. If these factors are limited, then inflation can be kept under control.
High Level of Employment [reduced unemployment rate] Unemployment levels are lower when there is high aggregate demand. However, when the rate is high, this has social and economical costs including Stress Depression Low self-esteem Arguments, separation, divorce Poverty Crime Increased burden on taxpayers More government spending on unemployment benefits Loss of international competitiveness
Demand-Side Policies – used by governments to directly target the level of aggregate demand. Expansionary Fiscal Policy – a form of demand-side policy involving reducing taxes, increasing government spending Expansionary Monetary Policy – this involves reducing interest rates to encourage spending Protectionist Measures – these will help to protect domestic businesses from international competition [i.e. tariffs] Supply-Side Policies – these aim to increase aggregate supply by lowering corporation tax or interest rates. The government may spend more on education and training for more skilled workers, however the effects of this will take longer to manifest. Types of Unemployment Frictional Unemployment – the time lag between people changing jobs Seasonal Unemployment – examples include a lack of tourists at the beach in winter, or temporary employment at Christmas Technological Unemployment – when people lose their jobs because of laboursaving technologies
Regional Unemployment – the different unemployment rates between regions, such as rural and urban areas Structural Unemployment – when employees are no longer needed as the demand for a product in a particular industry declines Cyclical Unemployment – when there is a lack of aggregate demand in the economy, such as a recession, and it affects all industries. It is also called demand deficient unemployment Economic Growth This is when the country’s economic activity increases over time. It is measured based on the GDP [Gross Domestic Profit]. When the rate of economic growth is high, it suggests that the average person is earning more. Below is the trade/ business cycle, which shows that economic activity fluctuates over time.
Peak or Boom – economic activity is at its highest level. Low unemployment and high spending. Businesses will have good cash-flow and people receive pay rises. Recession – a dip in economic activity for two consecutive quarters, bringing with it a decline in aggregate demand and rise in unemployment Slump or Trough – the bottom of a recession and the last stage of decline in the trade cycle. High unemployment, low spending. Businesses suffer poor cash flow, consumer confidence is low, lack of job security. Recovery or Expansion – when GDP rises after the slump. National income, consumption, investment, exports and employment all increase.
There are a number of ways that businesses can weather a recession Cost Reduction – cut energy bills, use alternative suppliers, relocate to cheaper premises, staff redundancies Price Reductions – this will help to sustain or increase sales Non-Pricing Strategies – repackaging, special offers, after-sales care to sustain or revitalise the volume of sales Branding – loyal customers will maintain income Outsourcing – produce overseas where it is cheaper and gain competitive advantage Improved efficiency in the production process contributes to economic growth through improved quality and quantity. Change in quality requires: Capital goods Education and training Health technology
while change in quantity requires changes in: Demography Participation rates Net migration
The main barriers to economic growth are: Poor infrastructure Lacking technical knowledge Unskilled labour force Rapid population growth High foreign debt repayments
Improving the Balance of Payments This is the record of the country’s inflow and outflow. It is made up of the current account [export earnings and import expenditure], which is split into the visible and invisible trade balances, and the capital account [flow of money for government reserves, foreign currencies or investment reasons]. Governments should aim to avoid deficit on the current account. The exchange rate measures the value of one currency in terms of another. When it is high, it means that export prices will be higher, so exporters lose price competitiveness. Devaluing the exchange rate gives domestic firms a price advantage. When it is low, there is depreciation in the currency, so domestic importers have to pay relatively higher prices, resulting in higher costs.
Fluctuation in foreign exchange rates can cause difficulties for businesses because they cannot make accurate forecasts, and planning is more difficult. Protectionism is when governments set up international trade barriers to protect domestic industries or correct disparity in its balance of payments. This safeguards domestic businesses from international competition. Tariff – or custom duties. A tax on imported products. Gives local business a price advantage. Quotas – a quantitative limit on the amount of foreign product entering the country Subsidies – when the government gives financial aid to domestic businesses to reduce production costs and give them a price advantage. Embargos – bans on international trade with certain countries due to political conflict, strategic reasons or severe health and safety concerns Technical and Safety Standards – strict standards on imported goods. The administration and compliance costs often cause higher prices on the foreign products.
These factors include behaviour patterns, tastes, fashions, culture and lifestyles. The age structure of the population is an important demographic, which alters over time. Businesses aim to understand and predict these trends to get an indication of the future market situation. Demographic trends may give a business a competitive advantage, depending on the nature of their operations. Such trends include the birth rate, life expectancy, attitudes to work, income distribution, education levels and population mobility.
Social Opportunities and Threats
Social attitudes can affect which goods and services are provided in the economy, such as attitudes to women, religion, animals, ethics, etc. Businesses may report their activities in these areas to please stakeholders. Demographic changes affect who the business can employ and the products they provide Multiculturalism and globalisation have changed many things, including food.
These days, technological changes are more frequent, and have an even greater effect on business activity. The most significant advance has been in communication technologies, including databases and electronic communications, which have allowed huge amounts of information to be shared at a smaller cost. With the rapid turnover of technology in the 21st century, it is essential that businesses are able to keep up to date with the relevant changes. Their production methods may soon become out of date or their products may be obsolete. In addition to this, new markets may open up.
Technological Opportunities and Threats
The internet is one of the biggest changes in technology, and has a profound effect on business activity. This has brought many opportunities including: Faster access to information Reduced language and cultural barriers Lower costs of production through e-commerce, etc
However, it also brings threats including: Price transparency Online crime Higher costs of production because of crime and training employees
Other technologies have also brought opportunities: o o o o o o New working practices Increased productivity and efficiency Faster product development New products New markets Job creation
and threats: o o o o Not reliable or secure due to hackers and failure Costly to upgrade and replace Shorter product life cycle due to continuous improvement Job losses in primary and secondary industries
Opportunities and Threats
People are more aware of environmental issues these days. Private sector businesses must recognise the negative externalities, or costs incurred by a third party. This includes pollution, waste and climate change. A business’ respect for the environment can affect their reputation and profitability. However, there are compliance costs for being environmentally friendly, so they must consider their aims and objectives as well. Seasons and weather affect business. Ski resorts and beach resorts each exploit seasonal weather patterns. Extreme weather can also affect other business activities. Threats can also come from health scares and epidemics due to loss of consumer confidence and business confidence.
Opportunities and Threats
Consumer Protection Legislation means that businesses must meet quality standards, they cannot give misleading information, and they are liable for damage or injury form their products. Employee Protections Legislation means that employees must be treated fairly, regardless of age, gender, race or religion Competition Legislation means that customers and small firms are protected from monopoly powers. It stops price fixing, choice restriction and unjustifiably high prices. It also protects copyright, trademarks and patents Social and Environmental Protection Legislation prevents or reducing the consumption of demerit goods [tobacco, petrol, illegal drugs, alcohol]. These otherwise cost society if their consumption is higher.
Opportunities and Threats
Benefits of acting ethically include: o o o o Attract and retain good quality workers Attract new customers and retain existing ones Generate good publicity Better public relation
However, acting ethically will often increase a firm’s costs due to the compliance costs.
SWOT versus PEST