Speaker 1: Hello, everyone. Welcome to Business School 101. As we know, a firm's operation and performance is inevitably influenced by its external environment. When managers decide to start a new business or enter a new market, they should coherently evaluate a firm's external environmental factors. A PESTO analysis is a framework or tool used by managers to analyze and monitor the macro-environmental factors that have an impact on an organization, company, or industry. PESTO is an acronym that stands for Political, Economic, Social, Technological, Environmental, and Legal Factors. Generally, the PESTO analysis focuses on a big-picture and long-term changes of a firm's external environment. So let's take a closer look at each individual element in the PESTO analysis. First, political factors. Political factors result from the processes and actions of government bodies that can influence the decisions and behaviors of firms. While political factors are located in the firm's general environment, where firms traditionally wield little influence, companies nevertheless increasingly work to shape and influence this realm. They do so by applying non-market strategies, that is, through lobbying, public relations, contributions, litigation, and more, in ways that are favorable to the firm. Besides domestic issues, political factors could also play a critical role in the arena of global trade. For example, while running for the U.S. presidency in 2016, Donald Trump expressed his disdain for many current trade agreements promising to bring manufacturing jobs back to the United States from other nations where they had been outsourced, such as China and India. After his election, he embarked on a protectionist campaign. In early 2018, President Trump stepped up his efforts particularly against China, threatening a substantial fine over alleged intellectual property theft and significant tariffs. The Chinese retaliated with a 25% tax on over 100 U.S. products. The U.S.-China trade war has caused economic pain on both sides and numerous studies have found that the increased tariffs forced many American companies to accept lower profit margins, cut wages and jobs for U.S. workers, defer potential wage hikes or expansions, and raise prices for American consumers or companies. Second, economic factors. Economic factors in a firm's external environment are largely macroeconomic, affecting economy-wide phenomena. Investors need to consider how the following five macroeconomic factors can affect firm strategy. Number one, growth rates. The overall economic growth rate is a measure of the change in the amount of goods and services produced by a nation's economy. In periods of economic expansion, consumer and business demands are rising, and competition among firms frequently decreases. During economic booms, businesses expand operations to satisfy demand and are more likely to be profitable. The reverse is generally true for recessionary periods, although certain companies that focus on low-cost solutions may benefit from economic contractions because demand for their products or services rises in such times. For customers, expenditures on luxury products are often the first to be cut during recessionary periods. For instance, you might switch from a $4 venti latte at Starbucks to a $1 alternative from McDonald's. Number two, levels of employment. Growth rates directly affect the level of employment. In boom times, employment tends to be low and skilled human capital becomes a scarce and more expensive resource. In economic downturns, unemployment rises. As more people search for employment, skilled human capital is more abundant and wages usually fall. Number three, interest rates. Another key macroeconomic variable for managers to track is real interest rates, which refers to the amount that creditors are paid for use of their money and the amount that debtors pay for that use, adjusted for inflation. Low real interest rates have a direct bearing on consumer demand. When credit is cheap because interest rates are low, consumers buy homes, automobiles, computers, and vacations on credit. In turn, all of this demand fuels economic growth. During periods of low real interest rates, firms can easily borrow money to finance growth. Borrowing at lower real rates reduces the cost of capital and enhances a firm's competitiveness. However, these effects reverse when real interest rates are rising. Consumer demand slows, credit is harder to come by, and firms find it more difficult to borrow money to support operations, possibly deferring investments. Number four, price stability. As we know, the lack of change in price levels of goods and services is rare. Therefore, companies will often have to deal with changing price levels, which is a direct function of the amount of money in any economy. When there is too much money in an economy, we tend to see rising prices. Indeed, a popular economic definition of inflation is too much money chasing too few goods and services. Inflation tends to go with lower economic growth. Countries such as Argentina, Brazil, Mexico, and Poland experienced periods of extremely high inflation rates in recent decades. In contrast with inflation, deflation describes a decrease in the overall price level. A sudden and pronounced drop in demand generally causes deflation, which in turn forces sellers to lower prices to motivate buyers. Deflation is also a serious threat to economic growth because it distorts expectations about the future. For example, once price levels start falling, companies will not invest in new production capacity or innovation because they expect a further decline in prices. In recent decades, the Japanese economy has been plagued with persistent deflation. Number 5. Currency exchange rates. The currency exchange rate determines how many dollars one must pay for a unit of foreign currency. It is a critical variable for any company that buys or sells products and services across national borders. For example, if the U.S. dollar appreciates against the Chinese Yuan, then firms need more Yuans to buy one dollar. This in turn makes U.S. exports such as Boeing aircraft, Intel chips, or Caterpillar tractors more expensive for Chinese buyers and reduces demand for U.S. exports overall. This process reverses when the dollar depreciates against the Yuan. In this scenario, the U.S. exports become more competitive in China. However, Chinese-made products such as toys, clothes, and electronics become more expensive for U.S. consumers. In summary, economic factors affecting businesses are ever-present and rarely static. Managers need to fully appreciate the power of these factors, in both domestic and global markets, to assess their effects on firm performance. Third, sociocultural factors. Sociocultural factors capture a society's cultures, norms, and values. Because sociocultural factors not only are constantly in flux but also differ across groups, managers need to closely monitor such trends and consider the implications for firm strategy. In recent years, for example, a growing number of U.S. consumers have become more health-conscious about what they eat. This trend led to a boom for businesses such as Chipotle, Subway, and Whole Foods. At the same time, traditional fast food companies, McDonald's and Burger King, along with grocery chains such as Albertsons and Kroger, have all had to scramble to provide healthier choices in their product offerings. Demographic trends are important sociocultural factors. These trends capture population characteristics related to age, gender, family size, ethnicity, sexual orientation, religion, and socioeconomic class. For example, the 2020 U.S. Census revealed that 62.1 million Americans are Hispanic, which account for 18.7% of the total population. In addition, Hispanics on average are younger and their incomes are climbing quickly. To respond to this trend, many companies such as McDonald's, AT&T, and Toyota are pouring dollars into the Spanish-language networks to promote their products and services. Another global demographic trend is that by 2050, India is expected to be the most populous nation in the world. China, the U.S., Indonesia, and Pakistan are expected to be the next four most populous countries in 2050. Besides the U.S., all those countries currently are still emerging economies. Their huge market size will provide numerous opportunities for companies. Fourth, technological factors. Technological factors capture the application of knowledge to create new processes and products. Major innovations in process technology include lean manufacturing, Six Sigma quality, and biotechnology. The nanotechnology revolution, which is just beginning, promises significant upheaval for a vast array of industries ranging from tiny medical devices to new age materials for earthquake resistant buildings. Product innovations include the smartphone, computer tablets, and high-performing electric vehicles. Progress innovations include social media and online search engines that respond to voice commands. If one thing seems certain, technological progress is relentless and seems to be picking up speed. Unsurprisingly, changes in the technological environment bring both opportunities and threats for companies. Given the importance of a firm's innovation strategy to competitive advantage, we will discuss the effective technological factors in greater detail in a separate video. Fifth, environmental factors. Environmental factors involve broad environmental issues such as the natural environment, global warming, and sustainable economic growth. Organizations and the natural environment coexist in an interdependent relationship. Managing these relationships in a responsible and sustainable way directly influences the continued existence of human societies and the organizations we create. Leaders can no longer separate the natural and the business worlds, they are inextricably linked. Negative examples come readily to mind, as many business organizations have contributed to the pollution of air, water, and land, as well as depletion of the world's natural resources. BP's infamous oil spill in the Gulf of Mexico destroyed fauna and flora among the U.S. shoreline from Texas to Florida. This disaster led to a decrease in fish and wildlife populations, triggered a decline in the fishery and tourism industries, and threatened the livelihood of thousands of people. It also cost BP some $50 billion and won half of its market. The relationship between organizations and the natural environment need not be adversarial. Actually, environmental factors can provide many business opportunities. For example, 260 million tons of plastic waste is generated across the globe every year, but only 16% gets recycled. The plastics industry has the opportunity to move away from a take, make, and dispose business model and adopt a circular model, which aims to eliminate waste across sectors while creating economic, societal, and environmental benefits. One promising circular process is pyrolysis, which uses heat and the absence of oxygen to reconvert plastic waste back into liquid feedstock. The benefits are economic as much as environmental, with a recycling-based profit pool estimated at $55 billion by the next decade. Sixth, legal factors. Legal factors include the official outcomes of political processes as manifested in laws, mandates, regulations, and court decisions, all of which can have a direct bearing on a firm's profit potential. In fact, regulatory changes tend to affect entire industries at once. Many industries in the United States have been deregulated over the last few decades, including airlines, telecom, energy, and trucking, among others. It is worth noting that legal factors often coexist with or result from political will. This especially can directly affect firm performance by exerting both political pressure and legal sanctions, including court rulings and industry regulations. Consider how several European countries and the European Union apply political and legal pressure on U.S. tech companies. European targets not only include Apple, Amazon, Facebook, Google, and Microsoft, the five largest U.S. tech companies, but also many startups. Europe's policymakers seek to retain control over important industries ranging from transportation to the internet to ensure that profits earned in Europe by Silicon Valley firms are taxed locally. Taken together, political and legal environments can have a direct bearing on a firm's performance. Now let's do a quick review of today's topic. A PESTLE analysis is a framework or tool used to analyze and monitor the macroenvironmental factors that may have a profound impact on an organization's performance. This tool is especially useful when starting a new business or entering a foreign market. PESTLE is an acronym that stands for Political, Economic, Social, Technological, Environmental, and Legal Factors. For managers, it is a good idea to run a PESTLE analysis at least every six months and identify changes to the external environment on a regular basis. By monitoring and responding to these changes, managers can keep their strategies fluid and current. So what do you think about the PESTLE analysis? Can you apply the PESTLE analysis to a company or business you are interested in? Please leave your thoughts in a comment below. Thanks for watching and I will see you next time.