The macro-environmental influences on your company
Every organization operates in a universe of different influences that can impact on its success or failure. For strategic corporate planning it is very important to be aware of these influences and even predict them.
There are factors in the macro-environment that companies cannot influence. These factors may be political, economic, social, legal or environmental. To identify these risks promptly, companies should perform an analysis of these factors – the PESTEL analysis.
PESTEL stands for
PESTEL influence factors as part of due diligence
The PESTEL analysis not only helps companies determine the market situation. As a form of proactive risk monitoring it can also be part of the due diligence check. Particularly in times of globalisation, supply chains often form extensive networks, with a number of countries being involved in production and marketing.
To protect both themselves and the organization, and of course for ethical reasons too, compliance managers need to ensure that the company’s supply chains do not involve economic crime and dubious or illegal practices. To respond quickly to changes in the business environment, organizations must be informed in real time about possible risks in the PESTEL categories. An efficient and safe method is a risk analysis tool such as LexisNexis® Entity Insight.
Even if the above examples of PESTEL influence factors initially sound too abstract to be identified as actual risks to your organization, you should nevertheless consider them. The supply chain pathway leading to your company may have been noted for its good quality for years, but there are still risks that you should not ignore. Here are a few examples:
- A natural disaster, such as a tsunami, occurs in one of your production countries.
- Regulatory or legal changes worsen import and export conditions for you.
- Product recalls hold up your production.
Your suppliers are linked to ethical problems such as modern slavery or corruption, putting you at risk of prosecution and reputational damage.
The individual PESTEL categories in detail
1. Politcal risks
2. Economic risks
3. Socio-cultural risks
4. Technological risks
5. Environmental risks
6. Legal risks
1. Political risks
We start with the “P”, the political risk, and consider the impact of political factors on supply chains and third-party risks.
We are frequently reminded that the global political landscape is highly volatile – and not only in emerging countries. The uncertainty occasioned by Brexit, economic nationalism in the USA and the rise of populism throughout Europe have contributed to a heightening of political risk. Political factors result in companies being exposed to risk.
Know the political risk factors
Globalization has ramped up expansion into new markets and made resilient, cost-efficient supply chains possible. Whencompanies leave their footprint in other countries and form ever more complex supply chains, they are also increasingly exposed to political risk factors in those countries, such as:
- political stability
- government type
- levels of bureaucracy and corruption
- press freedom and the rule of law
- trends in regulation and deregulation
- political measures relating to trade, tariffs and taxes
- legislation to protect the environment, workers and consumers
These factors directly influence companies’ ability to achieve their growth and profit targets. In consequence, prompt information about potential threats becomes a successfactor. Risk monitoring via PESTEL categories can facilitate creation of the necessary awareness and implementation of a proactive risk management system.
Consequences of political risk factors
News items, reports from NGOs and other data sources show how political risk factors can affect companies with multinational operations or supply chains. Take a closer look at the impacts of two key factors as examples.
- Political stability (or the lack of it)
Political instability as defined as a tendency to regime or government change, political unrest or violence in society, or instability and uncertainty in government policy such as in laws on regulation, taxes, property or human rights. Political instability can impact adversely on operating processes and supply chains and thus put productivity, quality and important relationships at risk. Unfortunately, political instability is hard to avoid if a company has an extensive supply chain. In a study by the American Productivity and Quality Center (APOQ), 63% of the companies surveyed reported that they had suppliers in parts of the world in which political chaos reigned. For example, Deutsche Post halted parcel deliveries in Ukraine because of the continuing unrest there – despite the fact that 620 German companies operate in Ukraine. And it is not just supply chains that are affected by political instability. The Swiss logistics company Astras reports a staff turnover rate of 20% among its employees in Ukraine.
- Political measures relating to trade, tariffs and taxes
According to the World Trade Organization (WTO), the number of restrictive trade measures introduced by WTO members continues to increase. The vast number of political trade measures can be difficult for companies to navigate, but with an average of 22 additional new measures appearing every month it is essential to be aware of the legislative plans of governments. Uncertainty for companies is further increased by the fact that the many existing trade relationships are also at risk. The “America First” policy of the Trump administration – with measures ranging from withdrawal from the Trans-Pacific-Partnership (TPP) to plans to renegotiate the North American Free Trade Agreement (NAFTA) – could lead to retrograde trade restrictions. The CIPS economist John Glenn comments:“In view of the threats to worldwide international trade relations, supply chain managers must be as aware of the political risks as of the risks from natural disasters and economic shocks.”
2. Economic risks
Let’s look at the “E” for “economics” and the role of economic factors in connection with the risks that companies face with regard to the supply chain and third parties.
The economic factors of production, consumption and capital flow have a significant influence on business success, sustainability and profitability. In the worst case, economic risks can disrupt supply chains and incapacitate companies. We take a closer look at the various types of economic risk and give some examples of how you can reduce your organization’s exposure to economic risk and make your business more resilient.
Economic factors affect business operations
Governments manage economic factors partly through tax laws and by controlling interest rates and state expenditure. Interest rates, exchange rates, recession, inflation, taxes and changes in supply and demand can pose risks to companies. Let’s look at the most important economic risk factors and explore their impact on business activity.
Interest rates: Interest rate risks are relevant to all companies that have interest-bearing assets such as loans and bonds. The specific economic risk arises from the fact that the level of the assets can change as interest rates fluctuate. Logically, this risk area is particularly relevant to banks. However, it can affect any company that uses loans as part of its business strategy.
Exchange rates: Exchange rates can be complex and volatile. And they affect all business activities that involve exporting or importing. Changes in exchange rates can determine how much a company must pay its international suppliers and thus affect profit margins.
Recession: An economic recession (on whatever scale) has the potential to alter customers’ inclination to buy, which in turn can force companies to reduce prices or radically modify their business plan.
A good understanding of the economic risks is an important factor in sustainable economic growth and smart decision-making. We have pinpointed some cases in which companies have considered their own economic factors and identified and reduced the specific risks.
Jessops: Adapting to recession and a changing market
In 2008 the economy of the United Kingdom went into recession.In the years that followed, unemployment rose and many employers were forced to cut wages, which meant that consumers had less money to spend. This had a major knock-on effect on retailers and Jessops, a British retail chain specializing in photographic equipment, found that sales of cameras and accessories plummeted. Fortunately, margins on services such as photo printing remained stable. Jessops therefore concentrated on becoming a market leader in the field of photo processing, thereby minimizing risk and boosting profit margins.
Changes among competitors in the market are another important economic influence on companies. Jessops had to battle with growing competition from online photo printing services and supermarket chains that offered lower prices.
The company responded to these economic risks with a more diverse multi-channel strategy. Customers can now order pictures and gifts over the counter or online. A rapid-response call centre handles the online services, thus utilizing Jessops’ extensive expertise in the industry. The company has also expanded its product portfolio. These countermeasures have enabled Jessops to gain a competitive advantage and so enhance its resilience to future economic risks.
IKEA: Responses to macroeconomic change
The global economic crisis of 2007-2009 once again demonstrated how extreme economic conditions can affect companies. However, IKEA suffered less from the crisis than many other companies because it has a cost leadership strategy that takes account of the economic risks to its supply chain and its core business activities. Although the company was forced to cut 5,000 jobs, its turnover in the second quarter of 2009 fell by just 1%.
Amazon: Dealing with exchange rates and tax risks
The stability and growth prospects of Amazon’s operations are directly affected by numerous economic factors, including tax and inflation rates, general and industry-specific economic growth, unemployment and changes in exchange rates. In 2016, takings from its international business constituted 32% of Amazon’s revenue.
The company is therefore particularly vulnerable to fluctuations in exchange rates. Changes in exchange rates caused revenue to fall in 2014, 2015 and 2016, with losses of USD 636 million, 5.2 billion and 550 million respectively.
When US President Donald Trump spoke in June 2017 of the need to introduce an Internet tax, he was referring directly to Amazon. This illustrates the potential impacts of economic factors – in this case the taxation of Amazon.
To mitigate these risks, Amazon is diversifying its portfolio, thereby reducing the impacts of exchange rates and the tax burden.
Economic risks and their impact on supply chains
Without efficient management of the economic risks in your business and supply chain, you put current and future transactions at risk.By taking advantage of up-to-the-minute information on economic and market trends, potential legal measures and other factors, you can respond proactively and thus mitigate risk. But how you can you obtain a better overview of economic risks? Make sure that you have a risk monitoring tool that you can rely on.
Organizations must incur calculated risks in order to achieve their goals. Better understanding of the PESTEL risks facilitates an agile response when serious problems emerge.LexisNexis® Entity Insight is a powerful tool that helps companies perform ongoing monitoring, tailored to company-specific risks. Find out more now.
3. Socio-cultural risks
We shall now look at “S” – the third letter in the PESTEL analysis. S stands for socio-cultural aspects and their impact on the supply chain and the risks to international companies from third parties.
Companies must increasingly rely on complex networks of suppliers and other third parties and they are therefore exposed to ever greater risks. To form an overall picture of the risk, companies must first obtain an overview of the socio-cultural risk factors and then focus on the most important details.
Know the socio-cultural risk factors
In view of the scope of modern supply chains and the growth targets set by companies expanding into new markets, companies expose themselves to considerable risk if they fail to assess global trends and local socio-cultural norms correctly. What socio-cultural risks are relevant to your organization depends on a number of different factors – from the countries in which your company operates to the nature of the products and services that you offer.
Most socio-cultural risk factors fall into one of three categories: demographic, societal/cultural and belief/attitude-related factors.
The demographic factors include:
- population growth
- age distribution and shifts in demand over time
- average family size and structure
- social diversity in terms of ethnic background, gender, income and education
- immigration and emigration rates
As has been demonstrated in recent years, immigration is often linked to forced labour; this results in significant reputational risk if cases of forced labour are identified in a company’s supply chain.
The societal and cultural factors include:
- the social class structure
- the assets of the local population
- changes in buying habits
- income disparities
- education level and access to education
- the level and availability of health care services
- social influencers such as grass-roots groups, gangs
- fashion and life style trends
- the influence of social media vs. traditional media
- the dominant communication technology
- the blend between traditional and introduced cultural customs
These risks do not apply only to emerging markets. For example, Brexit is already influencing buying behaviour, which could in turn impact adversely on companies’ turnover.
Factors relating to beliefs and attitudes include:
- religion: majority and minority religions, the influence of religious leaders on social behaviour and the role of religion as an instrument of social cohesion or division
- superstition: beliefs and local mythologies that influence behaviour
- celebratory customs and traditions
- banking, investment and saving practices
- acceptance of a wide range of people, countries and organizations
- interpretation of ethical or immoral behaviours
Although these factors may seem relatively harmless, the risk they pose is very real.Consider, for example, the Chinese practice of guanxi, defined as a “system of social networks and influential relationships which facilitate business and other dealings”. As part of this practice it is usual to give gifts, but companies must be careful to ensure that in engaging in this practice they do not infringe laws such as the Foreign Corrupt Practices Act (FCPA) and the UK Bribery Act.Awareness of socio-cultural risks of this sort enables companies to build up important business relationships while avoiding committing an offence.
The handling of socio-cultural risks can present a major challenge for international companies. Given the scope of modern supply chains, it can be virtually impossible to interact with a complete supply chain rather than just the first level. A more practical approach involves focusing on the most important suppliers and particular “hot spots” in the supply chain – for example, components such as mining or emerging markets that are particularly vulnerable to socio-cultural problems.
By concentrating on the most relevant social problems and setting up a proactive process for monitoring risk indicators in the news, social media and other important information sources, you improve your ability to predict and reduce risks and keep your company on its growth course.
4. Technological risks
We now consider the “T” for technological risk and the impact it can have throughout an organization. When assessing technological risk, it is important to be aware both of the aspects of current and future technology that can affect your company and of the technical risks along the supply chain.
“The deep interconnectedness of global risks means that technological transitions can exert a multiplier effect on the risk landscape,” says the Global Risks Report 2017 produced by the World Economic Forum. Indeed, the 100 most important business leaders who provided their risk assessments for this report cited the risks associated with artificial intelligence (AI), cyberattacks and data fraud particularly frequently, thereby emphasizing their growing fears in connection with the onset of the “fourth industrial revolution”.
Technological factors that could affect companies’ operations or their future viability may arise in connection with existing technologies or the development of emerging technologies. One has only to look at the impressive advances of recent years to see the speed at which these developments progress. Examples of such developments include the increased use of hybrid and electric vehicles, the simplicity of contactless payments and the significant impacts of online social media on our everyday lives.
This unchecked technological progress calls for rapid responses from companies to enable them to keep up with new trends and innovations and survive in a competition-oriented business environment or to boost visibility in order to be able to take more proactive, data-based decisions.
Technological factors that affect companies
- Risks: Technological innovations can give rise to operational and strategic risks that can interfere with company growth. For example, the meteoric (and technology-based) rise of Uber swept away traditional transport services, whose business collapsed completely.
- Opportunities: Disruptive digital technology impacted sharply on media organisations as the opportunities for accessing programmes multiplied. Streaming has deprived the traditional broadcasting stations of some of their viewers and made it possible to offer companies and consumers targeted services, cheaper media and greater reach.
- Risks: Many technological risks involve data security and cybercrime. Examples such as the hacking of the entire administration system of the UK’s health service, the NHS, demonstrate the devastating impacts of a security breach on business continuity and stakeholder confidence. Another risk arises from technical failure such as the failure of airbags to deploy, which impacted hugely on the automotive industry, or weaknesses in innovative technology as in the case of mobile phone batteries that overheated, posing a serious risk of fire. All these can lead to regulatory risks, such as the risk of fines, and adversely affect a company’s profits, image and overall growth. Disruptive technology can also restrict a company’s growth – for example, if a competitor is the first to introduce a new technology and thereby attracts a larger share of the joint customer base.
- Opportunities: The integration of modern technology (always provided that companies’ requirements, objectives and strategic considerations are not ignored) can result in huge benefits to companies and their customers and represent a long-lasting competitive advantage. The key to this is effective monitoring, which can help organizations identify new technologies that could stir up the market and enable them to respond proactively. Monitoring can also flag up potential warnings about technical failures. A good example in this area is the increasing use of blockchain and virtual currencies, which has attracted the interest of the supervisory authorities, leading to an increase in the regulatory risk.
- Risks: Investing in brand-new technology can be very expensive for companies, whether they are replacing an entire vehicle fleet with electric vehicles or making less sweeping changes such as providing employees with videophones.Without thorough analysis of the possible impacts of investment on your company, you can quickly be enticed into excessively costly investment or investment in the wrong technology.
- Opportunities: Companies that are seeking to use technology to gain a competitive advantage and that also have a viable strategy can profit greatly from the technology and achieve rapid and significant returns on capital as well as cutting costs.
- Risks: Almost any discussion about technology eventually touches on the issue of employment. AI and automation have already resulted in a decline in the “more traditional” forms of career. Robots that can build walls are just one example of this. This trend is not likely to stop. According to a study by the International Labour Organization, up to 50% of the entire labour force in Asia could be replaced by robots. Furthermore, employing maintenance personnel in countries with relatively unstable infrastructure could become a growing problem, leading to disruption of supply chains and hence financial losses and reputational damage.
- Opportunities: However, if these impacts are the subject of seamless monitoring throughout the supply chain, technology is highly likely to lead to better opportunities for skilled work in the fields of maintenance, programming and coding – possibly enabling companies to attract younger employees.
Technological risks and their impacts on supply chains
Technological factors are only some of the many external factors that can impact adversely on companies. They are therefore an integral part of the PESTEL analysis. Just as with the previously mentioned risks, supply chains are associated with a whole range of additional technological risks, such as the risk of an unstable technological basis. If work processes are performed in countries with relatively unstable infrastructure, this can result in operating problems or in problems in maintaining the technology. Disruption of the electricity supply can damage expensive equipment, or it may be difficult to hire maintenance personnel; these situations disrupt the supply chain and cause financial loss and/or reputational damage.Increased real-time awareness of technological and market trends enables you to respond proactively. However, in order to gain a better understanding of technological risks, you should ensure that you have reliable risk monitoring tools available.
5. Environmental risks
The second “E” in PESTEL stands for environmental risks and their impacts on organization.
“Risk is like fire: if controlled it will help you; if uncontrolled it will rise up and destroy you.” These words were spoken by Theodore Roosevelt more than a hundred years ago, but they are just as true today. However, “control” in this context does not mean that risks can be completely eliminated. In the case of many of the environmental risks that companies face, this would be totally impossible.Instead, risk management is about adapting dynamically to changing circumstances. To be resilient everywhere from the supply chain to the business as a whole, companies need a focused monitoring system that enables them to detect warning signals promptly.
Risk factors that you should consider
In the abstract sense, all external factors that could affect a company can be viewed as environmental risks.In the PESTEL context, however, the emphasis is on the concrete physical environment. The following examples illustrate how environmental factors can affect organizations:
- Climate, weather events and natural disasters: As a result of globalisation – especially within supply chains – companies must grapple with a greater range of climatic conditions and the associated weather events. The example of Toyota demonstrates that natural disasters, too, can disrupt supply chains. After the earthquake in Japan in April 2016, the automaker had to halt production at its plants across the country because of a shortage of parts.
- Climate change: The risks of climate change are often underestimated because the process appears to be proceeding so slowly. Climate change can nevertheless multiply the risks to supply chains.In some cases climate change may result in a shortage of resources such as water or energy. It can also amplify the effects of weather events such as hurricanes, snow storms and forest fires. These can in turn disrupt business operations or freight transport and hence plunge supply chains into chaos.
- Environmental pollution: Many supply chains use suppliers in developing counties where the environmental protection regulations are not yet strict enough for the resulting environmental pollution to cause legal problems. However, if consumers get the impression that companies are exploiting the more relaxed regulations, that can cause serious reputational damage. This was demonstrated by the huge protests that erupted at the start of this year when it emerged that major fashion houses such as H&M and Marks & Spencer were procuring fabrics from heavily polluting factories in Bangladesh and China. In her acceptance speech for the Riverkeeper environmental award, American clothing designer Eileen Fisher admitted:“The clothing industry is the second largest polluter in the world…second only to oil.”
- Availability of non-renewable materials: When there is a shortage – or a surplus – of non-renewable materials, organizations face a number of risks. For example, if a surplus of oil pushes prices down, this increases the strategic risks for oil companies. On the other hand, if prices rise as the result of an oil shortage, this presents an even greater range of organizations with financial risks – and transport may also be disrupted on account of the lack of fuel. Likewise, a shortage of non-renewable materials can result in an unreliable energy supply that can cause additional problems in the supply chain.
- Environmental regulations: The accelerating pace of climate change and the need for measures to combat environmental pollution in developing countries mean that regulations and laws are constantly evolving too. Companies must keep an eye on legislative activities that could result in laws that increase their risk exposure.
PESTEL-based monitoring improves identification of risk
Environmental risks can sometimes be foreseen without ongoing monitoring. Climate is generally a sufficiently well-known factor. For example, companies seeking to expand into the United Arab Emirates (UAE) are usually well-informed about the problems posed by operating in a hot, dry climate and they prepare themselves accordingly. Weather events, too, are often predictable: companies with operations or suppliers in coastal regions know that they face seasonal risks, such as hurricanes, that could disrupt their activities and they have appropriate action plans in place. However, as climate change progresses the known factors become less predictable. This is where continuous monitoring of environmental risks can be useful.
“The interconnected dynamics of geopolitics, technological advances, global economic integration, social instability, climate change and more means that the manifestation of one risk is increasingly likely to influence others,” states the Brink news service in its comments on global risks. It goes on to say that when a “known risk– hurricane, for example–meets with an emerging risk–rising tides–the outcome is not easy to predict. Thus, anticipating emerging risks enhances the ability to predict potential outcomes when risks intersect.”
6. Legal risks
Finally, we take a look at the “L” – the legal risks and their possible impacts across the organization. We shall show you how you can avoid unintentional infringement of rules and regulations in your company and its supply chains.
Regulations and laws are important aspects of attempts to create a level playing field for organizations and societies. They affect all areas of business. Legal factors can impact either positively or negatively on both the operations and the management of organizations – irrespective of the country in which the organization is located.
Regulatory risks can impact on sales, reputation and corporate success and can occur even if an organization is aware of its rights and duties. This is partly because suppliers and other third parties bring with them an enhanced risk of irregular conduct. It is also because the international regulatory landscape is in constant flux, which means that organizations must constantly gather real-time information on current and pending changes in laws and directives if they are to minimize risk. Legal risks pose a particular problem for internationally active and multinational companies, because these organizations must be familiar not only with the laws and regulations of the country in which they are headquartered but also with those of all the states or countries in which they have suppliers or customers.
Legal risk factors
- Tax and customs regulations
All organizations whose business activities involve the import or export of goods are affected by these regulations, which include national tax legislation, tax restrictions on certain areas of business, export and import restrictions, tax relief provisions, income taxes, corporate taxes and financial regulations.
- General economic regulations
All organizations run the risk of infringing general economic regulations, because this type of risk factor covers a large number of issues including foreign exchange and trade rules, property rights, state control of business activities (permits, licences, concessions), promotion of some types of undertaking (environmentally friendly goods, energy saving, healthy products), the protection of copyright and patents, date protection provisions and reporting obligations in connection with securities.
- Labour protection law
Because labour protection legislation can vary widely from country to country, organizations can easily be at risk of breaking the law or suffering reputational damage. For example, in some parts of Asia the laws on child labour – which have the approval of the International Labour Organization – permit the employment of children from the age of 14. Other law on the protection of workers includes anti-discrimination legislation, labour protection provisions, trade union law, minimum wage regulations and health and pension law.
- Consumer protection and foreign trade law
These laws are of particular relevance to companies that sell goods direct to end consumers or export goods to other countries. If new laws and legislative amendments are not constantly monitored and the necessary action taken, the flow of goods may be disrupted or halted on account of regulatory measures, with attendant consequences for the organization’s sales figures and its reputation with customers. These laws include measurement and calibration law, product description regulations, consumer credit law, laws on the protection of older workers, social requirements (societal values, transparency in the supply chain, modern slavery), trade sanctions and international trade rules.
Keeping on top of data protection law
Data protection law is designed to ensure that consumers’ personal data is stored securely. Failure to comply with it can cost companies dearly: under the European General Data Protection Regulation (GDPR), which entered into force on 25 May 2018, organizations can incur fines of up to four percent of their global turnover.Even shortly before this became law, many organizations were unaware of the possible level of the penalty. Legal tools of this sort are intended for use in the event of major offences, such as the hacker attacks on data held by the British telecoms provider TalkTalk in 2015, which affected more than 150,000 customers.
To avoid heavy fines, reputational damage and loss of shareholder confidence, organizations need to manage legal risks more efficiently. In the USA, changes in the management of data have already been brought about via the safe harbour scheme.But even there, there are still organizations that do not manage their risk efficiently. Six months after the European Court of Justice declared the previous rules on the trans-Atlantic exchange of data invalid, the Hamburg Data Commissioner imposed fines of €8,000 on Adobe, €9,000 on the Pepsi subsidiary Punica and €11,000 on Unilever because these companies had “failed to establish any permissible alternative methods.”
Employee and customer protection – “on the edge of legality”
Legal risk factors can also impact indirectly on organizations. For example, in September 2017 Uber’s operating licence in London was revoked, because the London authorities were of the opinion that in relation to the rights of its workers and the safety of its customers, the company was “on the edge of legality”.
On account of its working conditions, Uber also drew criticism from trade unions, legislators and traditional taxi drivers. The trade unions also called on London’s transport authority Transport for London to make renewal of Uber’s five-year licence conditional upon compliance with basic labour rights.
You can mitigate both direct legal risks in the form of fines, penalties and bans and indirect legal risks such as criticism of your practices and procedures from trade unions, activists, governments and customers by ensuring that your company is aware of all the legislation relevant to your business.
The legal risk and its impact on the supply chain
The greater your awareness of possible legal measures and – even more importantly – the greater your understanding of how they could affect your business, the more proactively you can avoid these risks.You can obtain a better overview of the legal risks by seeking out a risk monitoring tool that you can rely on.
PESTEL Risk Monitoring Tool
The challenge for organizations is to research all the necessary information and keep it up to date.With a tool such as LexisNexis® Entity Insight you can keep an eye on the PESTEL factors that are most relevant to the risks that you face – whether political, economic, socio-cultural, technical, legal or environmental.This customized approach to monitoring helps you avoid being swamped with information.It also enables you to detect warning signals earlier and respond proactively to reputational, legal, financial and strategic risks.