The external environment of a business refers to “uncontrollable factors”; in other words, those factors external to the company that affect its efficiency, profits, or ability to function. For example, a coal mining company is affected by government environmental regulations that limit the amount of damage it can do to the surrounding land and water. The regulations are part of the external environment of the coal mining company. In the case of a grocery store, the external environment would include customers; they are not part of the business, but what they do has a major effect on how the business functions.

Businesses can sometimes affect the external environment. Coal companies may lobby politicians to change regulations, for example, or a grocery store might attempt to influence customer preferences through advertising. Often, though, there are limits to how much a business can change externals. Instead, the business may need to adjust—for instance, by installing more pollution controls or lowering prices in the supermarket.

The external environment, then, forms the basis of business opportunities by creating conditions in which businesses can operate. It also influences business operations by imposing limits on the methods businesses may use to pursue opportunities. Further, the external environment creates risk, or the chance that a business will incur losses due to changes in factors over which it has no control.

One simple rubric used to analyze the external environment is PEST, an acronym that stands for Political, Economic, Sociocultural, and Technological factors. Political factors may include government regulations, taxation, and the views of local leaders on business policy. Economic factors might be whether the economy is growing or shrinking, whether unemployment is high or low, consumer demand, and whether a skilled labor force is available. Sociocultural factors could include the growth rate of the population, the age of the population, and education levels. Technological factors might be the possibility that research will result in new technologies and transportation networks in the area.

The PEST rubric can also be extended to include environmental, legal, and ethical external aspects. This model is known as STEEPLE (Social, Technological, Economic, Environmental, Political, Legal, Ethical). Environmental factors may include available natural resources, changes caused by global warming, and consumers' concerns about sustainable energy. Legal externals might be contract laws, labor unions, or employment laws. Ethical externals may include a firm's reputation, attitudes toward bribery, and expected business ethics. Some parts of PEST or STEEPLE may overlap (for example, political and legal concerns). There also may be external factors other than those covered under these rubrics. The PEST and STEEPLE methods of analysis are not meant to be exhaustive; instead, they are intended to help organizations begin to think about the external environment and how it may affect business.

No one is sure when exactly the term PEST came into use. The originator of the basic ideas in PEST may have been Harvard Business School professor Francis J. Aguilar (1932–2013), who in 1967 proposed ETPS (Economic, Technical, Political, Social) as a rubric to help think about the business environment. Other authors and thinkers added to the rubric, creating a host of acronyms, including PESTLE and STEEPLE. The formats suggest slightly different categories and approaches, but they all share the same basic idea. Businesses need to think systematically about external environments and adjust their business plans and models based on the legal, political, social, and economic environment.

 
Safety regulations and laws are one aspect of the external environment, factors outside of the direct control of an organization that can have an effect on its ability to function. © northallertonman/Shutterstock.com © northallertonman/Shutterstock.com

Business endeavors have always had to consider, and function within, an external environment. Consider the following historical examples for each of the aspects of STEEPLE.

Social For thousands of years the rhino horn has been considered to have strong medicinal properties. In traditional Chinese medicine, the horn is said to lower fever and is also used to treat snakebites, hallucinations, typhoid, headaches, and many other ills. Because merchants could make money selling the horn in China, it has been a valuable commodity there (this continues to be true to a lesser extent). The social belief in the uses of the rhino horn is a necessary condition for businesses to develop around offering the horn for sale. In places and times where the horn has not been seen as useful (such as the modern United States), this particular type of business is not as profitable. Looking at history, therefore, it becomes clear that what is valuable, and what is not valuable, is itself a matter of external environment. Oil is not in itself valuable; it is valuable because the modern world is one in which the uses of oil are important. If that were to change—for example, if solar power developed and became the standard energy source—oil companies would have to adjust to the external environmental fact that their product was no longer needed or wanted.

Technological Technological developments can have an important effect on business, and reacting to those developments can make or break a company. For instance, many artisans were forced out of business by the Industrial Revolution of the 18th and 19th centuries, when factories began to mass-produce consumer goods at a lower cost. A more recent example of technological change affecting businesses is the bookstore chain Borders.

Borders, founded in 1971, was very successful as a large book retailer through the mid-1990s. It reacted slowly, however, to the development of the Internet and online retailing. The company did not develop its own website quickly and moved into selling music and CDs just as the Internet and digital sales were cutting into that market. In contrast, its competitor Barnes & Noble was more aggressive about selling online and developed an e-reader for digital books. As a result of their different reactions to the external technological environment, Borders went out of business in 2011, while Barnes & Noble has been able to remain competitive.

Economic The Great Depression (1929–1939) was an extremely challenging external environment for many businesses throughout the world. In several countries the unemployment rate reached as high as 30 percent, so consumers had relatively little money. Some businesses reacted to this environment by cutting advertising budgets. This actually created opportunities for companies Page 92  |  Top of Articlethat continued to spend on advertising. For example, before the Great Depression the Ford Motor Company sold 10 times as many cars as the Chevrolet Motor Company. Ford's financial position was precarious, however, and it was not able to advertise aggressively once the Depression hit. In contrast, Chevrolet expanded its advertising, and by 1931 it was outselling Ford. As this example illustrates, even the worst external economic situation can be used to an advantage by well-managed companies.

 
STEEPLE analysis is a useful tool for evaluating and understanding the external environment. It identifies social, technological, economic, environmental, political, legal, and ethical factors outside of the direct control of the organization that can have a profound effect on its ability to function. Illustration by Lumina Datamatics Ltd. © 2015 Cengage Learning^® SOURCE: LouAnn Conner. http://www.slideshare.net/lconner/steeple. Illustration by Lumina Datamatics Ltd. © 2015 Cengage Learning^®

Environmental For businesses the availability of natural resources is a major part of the external environment. A good example of this is the blue dye called indigo. Indigo comes from a plant of the Indigofera genus that flourishes in warmer climes. The dye has been used in Asia and West Africa since antiquity, but it only became widespread in Europe after 1498, when sea routes were opened to India. Prior to that, most blue dye in Europe was made from a plant called woad.

As Europe began importing large quantities of indigo, blue dye became much cheaper than it had been, lowering the prices of many textiles. Woad merchants in Europe reacted to this by trying to ban indigo. In France and some parts of Germany, it was illegal to use indigo during the 16th and 17th centuries, and dyers who did use indigo could be punished with death. Nevertheless, the demand for indigo increased, which was one reason that the plant began to be cultivated in the Americas. Thus, dyers, farmers, and traders in Europe, India, and the Americas all had to adjust their businesses on the basis of environmental factors—where indigo could grow and where it could not.

Political One extreme instance in which political considerations had an effect on businesses is the fate of Jewish-owned businesses in Nazi Germany (1933–1945). Before the National Socialist German Workers' (Nazi) Party took control, Jews were quite integrated into German society, and many of them owned or operated businesses. One of the first things the Nazis did when they came to power in 1933 was to target these businesses for a nationwide boycott. Nazi Party forces stood in front of Jewish shops, intimidating and sometimes attacking anyone who tried to purchase goods.

This boycott was not in itself very successful, but it was one of the first incidents in a long-term campaign to drive Jews out of business. Eventually, many Jews were forced to sell their businesses at a serious loss or else were Page 93  |  Top of Articleactually physically driven away. Non-Jewish business owners were often forced to fire Jewish employees. These politically driven changes to the external environment, therefore, made it impossible for Jews to run businesses.

Legal Laws can affect businesses in any number of ways. As discussed above, dyers in Europe during the 1500s were often not allowed to use indigo dye; in this case, the external legal environment had a major impact on what materials businesses could use and, as a result, how cheaply they could make and sell their products.

The indigo trade also serves as an example of how different parts of STEEPLE often influence each other. The climate in Europe prevented growing indigo; the laws in Europe prevented importing indigo. Dyers in Europe were thus prevented from using indigo due to a number of external factors. STEEPLE helps break the external environment down into separate parts, but it is important to remember that those parts are not necessarily separate. Rather, different externalities work together to create a total business environment—in this case, one in which access to indigo is very limited.

Ethical Businesses may feel pressured to change their policies for ethical reasons. For instance, doctors and hospitals were reluctant to partner with the retail pharmacy chain CVS for ethical reasons given the store's sale of tobacco, which carries serious cancer and other health risks. In response to such concerns, in 2014 CVS stopped selling tobacco products and announced plans to offer a smoking-cessation program as well as to expand its number of in-store medical clinics.

 
Two restaurant workers input customer orders using a tablet. Technological developments, such as the introduction of touchscreen tablets at the turn of the 21st century, are one component of the STEEPLE (social, technological, economic, environmental, political, legal, and ethical) model of the external environment. © Christopher Villano/Corbis © Christopher Villano/Corbis

PEST analysis is often paired with, or seen as a part of, a planning method called SWOT, which businesses use to analyze both internal and external factors. The letters in SWOT stand for (internal) strengths and weaknesses and (external) opportunities and threats. It can useful to employ both SWOT and PEST, because SWOT is a reminder that businesses need to pay attention to internal as well as external factors.

For instance, a restaurant's success will depend a great deal on external factors. Is the economic climate good enough that people are willing to go out to eat? What are the specific zoning regulations or tax laws that apply to businesses operating in the area? Is the kind of food being served popular among residents in the area? All of these are questions about the external environment. The restaurant owners can affect these factors in some ways (they could lower prices if the economic climate is bad, or they could lobby to lower taxes), but to some extent, the external environment is outside their control.

The restaurant's success, however, is not only dependent on external factors. Internal factors are also very important. Specifically, a SWOT analysis requires a business to honestly evaluate its own strengths and weaknesses. Does the restaurant have a talented chef and appetizing menu? Is its service prompt and friendly? Are its prices competitive? Is its accounting in order? Is it paying a competitive wage that can attract high-quality employees?

It may seem like internal factors are easier to control than external ones. Indeed, they can be controlled to some extent; for instance, if the restaurant's chef proves to be unskilled or unreliable, the owners can hire a new one. Internal and external environments are often intertwined, however. Hiring a good chef, for example, depends in part on external factors such as whether the restaurant is in an area where skilled employees are available. Whether the restaurant can offer competitive prices may depend on the economic environment and if people are willing to go out to eat on a regular basis.

SWOT encourages the restaurant to evaluate the external environment on the basis of its internal strengths and weaknesses and its internal strengths and weaknesses on the basis of the external environment. Neither the business nor its environment are static; rather, internal and external factors influence each other. Success involves tailoring strengths and weaknesses to the requirements of the external environment while also figuring out how to affect the external environment given the business's known strengths and weaknesses.

One aspect of the external environment not always included in PEST and STEEPLE is business competitors. Competitors can have a major effect on the success of a business. As with other external factors, a business can sometimes affect its competitors, most obviously by forcing them out of business or, less dramatically, by lobbying for legislation. Like other external factors, however, Page 95  |  Top of Articlecompetitors are also outside of a business's control in many ways. A business must evaluate and use its strengths and weaknesses in order to compete effectively.

The story of Craigslist is an example of how a business can transform the external environment in ways that make it very difficult for its competitors to adapt. Before the advent of the Internet in the late 20th and early 21st centuries, newspapers made a significant amount of their revenue from classified ads (ads placed by individuals offering or soliciting goods or services). A plumber might advertise his or her services in a classified ad; someone else might advertise “Wanted—Used Car.” Classifieds are relatively inexpensive, and the ads are small; they are typically placed by people rather than by businesses and advertise the desire to buy or sell a single good or service. Newspapers would run hundreds of classified ads, and it was a major source of revenue.

Craigslist, an online bulletin board on which people can post to advertise goods or services, or to advertise a request for goods or services, debuted in the San Francisco, California, area in 1996 and grew to be a nationwide service by 2000. Posting ads on Craigslist is often free or low cost, effectively undercutting newspapers. Craigslist also has a number of competitive advantages over newspapers, such as ease of access, an in-depth search function to make it easy for customers to find relevant information quickly, and fewer limits on space, allowing posters to give more information about their offerings, including photos and hyperlinks.

In the new external environment created by Craigslist, newspapers were hard hit. According to a 2014 study by Robert Seamans and Feng Zhu, approximately US$5 billion in revenue lost by the U.S. newspaper industry between 2000 and 2007 could be attributed to competition from Craigslist. This had major effects on every aspect of the newspaper business. Papers had to charge less for ads and classifieds as well as raise the price of each issue. Many papers, including many alternative weeklies, were forced out of business. Other papers were radically transformed. The Chicago Reader, an arts and culture weekly in Chicago, for example, had long consisted of four weighty sections. By 2014 it contained just a single, relatively thin section; both the huge classifieds section and the lengthy feature stories were gone.

In this example, changes in competition were enabled by changes in technology, another demonstration of the interdependence of external factors: the Internet enabled Craigslist to create a new kind of business, which competed for ads with regular newspapers in new ways. In response, newspapers had to change their business model and redefine their product. Changes in the external environment prompted internal changes, some of which were successful and some of which were not.

Problems with PEST Analysis

PEST and STEEPLE are useful ways to think about external environments. They attempt to systematize business planning. As such, they can be a good way to bring into focus the kinds of factors that a business must consider, such as environmental regulations, economic outlook, and political issues.

An analysis based on PEST, however, is only going to be as good as the research and thinking that go into it. A business doing a PEST analysis may fail to consider important factors or may fail to accurately predict changes in external environment. PEST is important, but it does not insure a business against all dangers or point to all opportunities.

Many of the examples discussed above illustrate ways in which PEST or STEEPLE analysis can be limited. The Ford Motor Company was no doubt paying attention to external economic issues, but, like most businesses, it did not anticipate the Great Depression, and so it lost market share. Newspapers did not anticipate a new competitor like Craigslist. Borders did not realize how online booksellers would change the book market.

The case of Borders, however, also demonstrates the importance of continually analyzing and reconsidering the external environment. Borders was not simply put out of business by unanticipated changes. Rather, it failed to adapt to online changes numerous times. Barnes & Noble was also hard hit by new Internet competition, but the company made more considered changes to its business model and moved more aggressively to develop a website and digital retail approach. As a result it was able to continue to function, despite the new conditions.

Analysis of the external environment, then, is not a fail-safe, but it is necessary. Businesses need to pay attention to the environment in which they operate and make adjustments, even as they must realize that no adjustment is perfect and no environment—political, social, or economic—lasts forever.

New technologies can cause business environments to change very quickly. At the same time, technology offers better ways to predict changes, which can give businesses more information and therefore more time or capacity to change.

A good example of this is global warming. Industrialization and the modern fossil-fuel-burning economy is changing the world's climate in unprecedented ways. Among other things, the rise in global temperatures is expected to cause ice melt and rises in sea levels, threatening coastal areas. Businesses that rely on access to beach fronts—whether real estate or tourism businesses—may be seriously damaged as coastal waters rise. Changes in climate may also affect seasonal businesses; ski resorts, for instance, can expect to see less snow. Farmers in areas that used to get plenty of rain may be faced with more frequent droughts.

These are large-scale changes, but they are also anticipated changes. Ski businesses, for instance, should be aware that there will be less snowfall and may be able to invest in snow-making equipment. Businesses on the coast can buy more insurance and may in some cases consider relocating inland. Farmers might think about switching to less water-intensive crops. Other businesses might even see global warming as an opportunity. A consulting firm might start to specialize in advising other businesses on adapting to climate change, for example, or green-energy firms might see increased sales as worries about global warming increase.

None of these is a surefire way to save a business. The dislocations caused by global warming will most likely result in severe losses for some companies. As always, however, companies that take account of the external environment, and that pay attention to the best available information, will be better positioned to succeed in the future.