Strategic Analysis: External Environment: formula sheet

Key formulas

PESTLE factors

P + E + S + T + L + E = Political, Economic, Social, Technological, Legal, Environmental

Name all six in this order. Some books write PEST or PESTEL; the content is the same.

Purpose of the analysis

Macro factors → Opportunities (O) and Threats (T) → input to SWOT and strategy

Always end each factor with its impact, favourable or unfavourable, on the firm.

Scope rule

Macro environment = forces outside the industry that the firm cannot control

Competitors, suppliers and buyers belong to the industry (Porter's Five Forces), not to PESTLE.

Threat of new entrants

Higher barriers to entry → lower threat; lower barriers → higher threat

Barriers include economies of scale, capital needs, brand loyalty and product differentiation, switching costs, access to distribution channels, government policy and cost advantages independent of scale.

Bargaining power of suppliers

Few suppliers, unique inputs, high switching cost → high supplier power

Also high if suppliers can integrate forward, or if the industry is not an important customer for them.

Bargaining power of buyers

Few large buyers, standard products, low switching cost → high buyer power

Also high if buyers can integrate backward, are price sensitive, or are well informed.

Threat of substitutes

More close substitutes at attractive price-performance → higher threat

Substitutes meet the same need in a different way. They cap the prices an industry can charge.

Rivalry among existing competitors

Many or equal-sized rivals, slow growth, high fixed costs, low differentiation, high exit barriers → intense rivalry

Intense rivalry leads to price wars, heavy advertising and lower profit.

Overall industry attractiveness

Strong forces → low profit potential; weak forces → high profit potential

Use this as your concluding line in every answer.

Industry attractiveness (judgement rule)

Attractiveness = f(growth, five forces intensity, profit potential, risk) relative to the firm's capabilities

There is no numeric formula. Write a reasoned verdict, not a score, unless the question gives a scoring grid.

Industry analysis checklist

Structure + Growth + Five Forces + Life cycle stage + KSFs + Competitors

Use this list as your answer skeleton for any open-ended question.

Competitor analysis components

Future goals + Current strategy + Assumptions + Capabilities

These four elements let you predict a rival's response profile.

Key success factor test

KSF = a factor that most customers value AND that decides who wins in the industry

If it does not influence buying or profit across the industry, it is not a KSF.

PLC stages

Introduction → Growth → Maturity → Decline

Some texts add a shake-out between growth and maturity for industries. Always name the stage before suggesting strategy.

Experience curve rule

Unit cost falls by a roughly constant % each time cumulative output doubles

A concept rule, not an exact law. Use it to explain cost advantage from cumulative volume.

Illustrative 80% curve

Cost after doubling = 80% × earlier unit cost

The percentage varies by industry. Use it only if the question gives the rate.

Sources of experience effect

Learning + Specialisation + Process improvement + Product redesign + Scale

A list to quote when asked why costs fall.

Quick revision

• The environment has internal, micro (industry or task) and macro (general) levels.
• PESTLE stands for Political, Economic, Social, Technological, Legal and Environmental factors.
• PESTLE scans the macro environment; it does not analyse a single industry in depth.
• Porter's Five Forces: threat of new entrants, bargaining power of suppliers, bargaining power of buyers, threat of substitutes, and rivalry among existing competitors.
• Strong forces reduce industry attractiveness and profit potential; weak forces improve it.
• High entry barriers lower the threat of new entrants.
• Easy availability of substitutes limits the price an industry can charge.
• Product life cycle stages are introduction, growth, maturity and decline.
• The experience curve says unit costs tend to fall as cumulative output grows, because of learning and scale.
• External analysis finds opportunities and threats; internal analysis finds strengths and weaknesses.
• In a case answer, always link each factor to a fact in the case and end with the impact on the firm.

Common mistakes

• Treating customers and competitors as part of the macro environment. Fix: Remember that external has two layers. Customers, suppliers, competitors and financiers are micro. PESTLE factors are macro.
• Saying the firm can control its external environment. Fix: Say the firm cannot control external factors but can respond to them and sometimes influence them, for example through lobbying.
• Only listing factors without saying their impact. Fix: After every factor, add a clause: it is an opportunity or threat, and how it changes demand, cost or risk.
• Mixing Political and Legal factors. Fix: Political is policy and stability. Legal is binding law and regulation. Put each point under its primary heading and mention any other angle in the impact line.
• Listing the five forces with textbook definitions but no link to the case Fix: Pick one fact from the case for each force and state the rating. Case-based answers earn marks for application.
• Confusing Porter's Five Forces with PESTLE Fix: PESTLE covers the macro environment (political, economic, social, technological, legal, environmental). Five Forces covers industry competition. Mention the level when asked for a difference.
• Treating key success factors as the firm's own strengths. Fix: Remember that KSFs belong to the industry. Strengths belong to the firm. Compare the firm against the KSFs to find gaps.
• Listing Five Forces without a verdict on attractiveness. Fix: After the forces, state whether the combined pressure makes profits high or low, and say so clearly.
• Treating the product life cycle and the experience curve as the same thing. Fix: Remember: PLC tracks sales and profit across stages. Experience curve tracks unit cost against cumulative output.
• Saying unit cost falls with annual output rather than cumulative output. Fix: Always write 'cumulative volume' or 'accumulated experience' in your answer.

Exam tips

• Always split the answer into internal, micro and macro. This structure is easy for examiners to mark.
• In case-based questions, name each factor from the case before explaining its effect.
• Link every answer to strategy formulation, opportunities and threats in the last line.
• For MCQs, test whether the factor is controllable. If the firm controls it, it is internal.
• Do not spend long on this topic; it is short and scoring, so aim for crisp bullets with examples.
• Always write all six headings, even for a short answer. Missing one factor loses easy marks.
• Read the case for clues first. ICAI-style questions usually hide one clue per factor.
• In MCQs, look for the keyword that identifies the factor and ignore the rest of the sentence.