Some risks are extremely difficult to assess, especially if they are external to a company, or if there are “macro” type influences on your company (such as environmental, economic, geopolitical, societal, etc.). One way to help define these risks is to consider using the PESTLE analysis method. The PESTLE analysis has many uses and helps a company to determine its strategy. It considers all various influential (and often local) factors that can affect a company’s products—regulatory, child labor, acts of nature, and other unique types, which certainly are not within the control of a company and its leadership. It is broadly used by many companies such as those shown in Figure 11.1.
There are six categories of the PESTLE process (see Figure 11.2):
1. Political risks,
2. Economic risks,
3. Social Cultural risks,
4. Technological risks,
5. Legal risks, and
6. Environmental risks.
As you continue to perform your risk assessment process, just think back about two years and remember the impact of certain risks that happened (such as COVID-19 pandemic or conflict in Ukraine) and presented companies with unexpected issues. All supply chain activities were hit hard, which subsequently rippled into sales. It became clear that most current supply chains were not “built” to adjust to such events. The dependency of companies on other countries became even more obvious, especially when it comes to logistics, materials/components, and production—such as China (rare earth minerals, manufacturing), Taiwan (components), Ukraine (neon, wheat), just to name few examples. Most companies scrambled to alter their supply chain model in order to survive.
Figure 11.1 PESTLE analysis—across the globe
Figure 11.2 PESTLE analysis model
We will go through each one of the PESTLE risk categories in more detail as follows:
Political risks: One can certainly understand how supply chain and third-party risks became a major factor for a company. There are many geopolitical factors surrounding these previously mentioned examples, which suggest that the global political landscape is extremely volatile in both countries with emerging economy as well as in countries with more established economies. There have been many examples of this, such as Brexit. The economic nationalism in the United States and the rise of populism throughout Europe have contributed to a dramatic political risk. As a result, the geopolitical factors by definition of the current day events create exposed risks to a company.
The globalization of markets and companies has ramped up the need to ensure there is a seamless and cost-efficient relationship with supply chain vendors. Most global companies have a footprint that covers most of the world, whether it is sales or supply chain to support the sales. There are many factors related to political risks, such as the instability of the political environment, where the change of leadership can shift the direction of a country’s future and relationships with other countries. In many countries, there are also many levels of corruption in bureaucracy. And of course, the freedom of speech and press and the rule of law dramatically differs across the globe, which means that companies have to understand the local regulations and what drives the political behavior of a country and adjust the strategy accordingly.
Also, within the political area is the vast regulation and deregulation over many industries that are constantly changing. As a result of some of the changes, the impact on international trade, tariffs, and taxes (that impact not only the cost of a company’s product but also their ability or inability to meet on-time deliveries) can be significant. The amount of legislation that has been developed over the last decade or so—to protect the environment, workers, and consumers—has increased 10-fold and requires companies to adapt.
In conclusion, all of these factors require a company to be proactive in the risk management process. This does not apply only to current products and relationships, but also to those that are strategic for the company’s future. These are the key areas in both short term and particularly long term for a company to be able to achieve their growth and profit targets. The PESTLE analysis can facilitate such proactive work and assist in making strategic decisions in the best interest of a company.
Economic risks: There are many economic factors such as working capital flow needed to develop the business capabilities, and also the consumption and production that is required for business success, both current as well as future to ensure a profitability in the long term.
There are several ways governments can influence the countries’ economic factors, and come primarily through taxation and tax laws, as well as managing interest rates. Interest rates, foreign exchange rates, taxes, and even inflation and recession, as well as the changes in demand can create substantial risk to companies. Interest rates, for example, particularly have a relevance for companies that have interest-bearing assets and the risks really arrive from that as interest rates fluctuate. Most companies must establish lines of credit and basic loans to be able to meet the cash flow needs of their business strategy.
Exchange rates also have a direct impact on what a company must pay its international vendors. Most exchange rates are very volatile and can be volatile even over a very short period of time, which can change all the rules related to importing and exporting goods and services.
Social risks: Societal risks not only affect present day but also impact future business, especially for companies intending to expand into new markets. Within this category, there are several demographic factors that need to be taken into consideration from the diversity of the people (including income and education base, as well as their gender and background), and the frequency for which they depend on immigration. The population growth and patterns of births and deaths are also important factors, as well as the age distribution reduces the population of workers to contribute to countries’ economies and ultimately provide workforce for a company.
Societal risks also include personal beliefs such as religion. There are many followers of major religions who are driven by a tremendous influence of their religious leaders. There are also other types of beliefs such as local mythologies that influence behavior. These are potential risks that one just does not normally think about until they actually start doing a PESTLE analysis. While they seem to be a little bit benign in severity, they can become very significant very quickly.
Technology risks: Every company needs to anticipate changes especially when it comes to future technologies, as they will affect a company from both an operational standpoint as well as from a product development standpoint. Some of the most important technological factors gaining rapid attention today include cyberattacks, data theft and fraud, personally identifiable information fraud, and so on. On a positive note, some technologies such as artificial intelligence, machine learning, and natural language processing create a new era of more efficient information gathering and processing to influence business decisions. Risks then become relative to accuracy and timeliness of information and the decisions.
Many of the technology risks can be very disruptive. For example, the changes in technology had changed the music and entertainment industry dramatically, from the types of media the music was distributed on to online streaming today. Service organizations had to adapt their business models. For example, a group of service providers replaced the taxis in many cities. These changes happened fairly rapidly and offered more efficiency. Many taxi companies did not anticipate this shift and found themselves to be in a very dismal financial situation.
Some changes have longer acceptance period before such innovations are beginning to be accepted. For example, blockchain and cryptocurrency have been around for several years, but it was not until some of the major companies, such as Google and Tesla, started to buy cryptocurrencies and in the process boosted the technology behind the blockchain.
Other examples include self-driving and electric cars. When you think about those innovations, there is a certain number of legal risks that can amount exponentially. Supplying batteries for hybrid or electric cars or supplying batteries for solar power backups have indeed changed many companies’ or country’s technology focus, but they all represent certain level of financial risk that will ultimately impact a company’s strategic risks.
Environmental risks: These types of risks are becoming even more important, especially in the context of global warming and climate change. With the numbers of wildfires, tsunamis, earthquakes, volcanic eruptions, and so on, there is likely to be another dramatic impact on supply chain efficiency. While natural disasters are becoming more frequent and are undeniably a result of climate change, the climate change alone is often underestimated because of the perception of “long time” required for the climate to change. However, when these events happen, they have a major catastrophic impact on all facets of business. The impact of floods in Thailand on hard drive industry in 2011 was historical. The pandemic over the last two years affected freight transport, customs at the import harbors, and so on, and continue to breed a layer of risk at all levels and all steps of a company’s business model.
The good news is that since there are now more environmental concerns than before, regulations to protect the environment are becoming much stronger though in many cases they also create legal liabilities. While companies may take advantage of the few areas where the regulations are still relaxed, but ultimately doing so presents high reputational risk to a company.
Another topic within this category is the renewable materials, whether there is excess supply or restricted supply, and supply versus demand. Oil shortage has also created a great range of financial risks for organizations. The cost of transport has gone up dramatically to the extent that companies are required to absorb some of the higher freight cost and cannot always push all those additional cost onto consumers. Even if they are able to do so, the price increases generally lag the risks that are currently happening and could lag for two or more years before they are able to increase the prices to offset some of these more environmental or economical type of risks. Surcharges are becoming a common practice for many companies to counteract the cost increase in the short term. For some companies, it may be too late.
Legal risks: The PESTLE approach can be used very effectively especially in assessing those risks that relate to external influence and actions that are not within the control of a company and touch heavily on the geopolitical risks as well. This type of analysis is used by many Fortune 1000 companies, not only to assess the risks but also to help them understand new markets that they intend to start servicing. All the local laws and regulations, and economic conditions, can be very expensive if not recognized and anticipated in the very early expansion planning stage and incorporated into the business model.