Two of the most famous strategy frameworks for understanding the environment that a firm operates in are the PESTEL (or simply PEST) framework and Porter’s Five Forces framework. While both consider key external influences that can impact firm profitability, as explored below, there the frameworks draw attention to different parts of the firm’s external environment.
PESTEL - understanding the broad macro-envrionment
The PESTEL framework helps understand the impact of components of a firm’s environment that are external to both the firm and the industry – broad factors that in some ways influence all industries and firms. While their impact may be greater on some industries compared to others, the PESTEL components are largely external to the industry itself.
The components of the PESTEL framework include:
- Political: Decisions made by the government, including decisions on the legality of various industries, taxation policies, or environmental standards.
- Economic: The impact the state of the economy can have on the company, including the availability and cost of capital for firms, economic growth rates, or exchange rates.
- Social: The impact of changing demographics and social trends.
- Technological: The impact of new technologies on companies
- Ecological: How the factors such as weather, climate, natural disasters, and pandemics influence companies.
- Legal: How laws are implemented and enforced – for example, consumer-focused laws, anti-trust legislation, environmental laws, and employment laws that companies must follow.
Porter's Five Forces: Understanding the industry that a firm operates in
While the PESTEL framework is intended to help understand the broad macro-environment that a company is operating in, Porter’s Five Forces is a framework to understand the industry that a firm operates in. It helps highlight how the relative powers of buyers and suppliers, as well as competition from new entrants, substitute products, and rivalry between competitors, influences the extent to which an industry is able to capture the value that is created.
The components of Porter’s Five Forces include:
- Buyer power: The extent to which buyers are able to put pressure on the price of the good – potentially due to their size or importance.
- Supplier power: The ability of suppliers to increase the costs of inputs.
- Rivalry: The extent to which firms already in the industry compete away the industry profits – potentially through undercutting one another.
- Threat of new entrants: How easy it is for new firms to enter the industry – potentially increasing the levels of competition within an industry over time.
- Substitute products: The extent to which there is competition from substitute products.
Both frameworks draw attention to external factors - largely outside of the firm's direct control
As illustrated above, both Porter’s Five Forces and the PESTEL analysis examine different components of a firm’s broad environment: trends that apply across industries in the case of PESTEL, whereas factors that are important within an industry in the case of Porter’s Five Forces.
The frameworks complement one another – allowing greater understanding and awareness of broad factors that can impact a firm and industry.