SME Lending – PESTEL
For Business Finance Professionals, a PESTEL (or PESTLE) analysis is a framework used to assist SME owners and managers in recognising, understanding and monitoring the macro-environmental factors that can have a defining impact on a SME’s operations and success.
In conjunction with analysing the Market Environment and using tools such as Porter’s Five Forces, PESTEL provides clarity of the SME’s opportunities, threats and positioning given the interrelated internal and external factors.
It is also part of the proactive credit analysis and risk assessment used by lenders in undertaking their due diligence and determining the appropriateness of providing funding to a particular SME.
Globalisation has made PESTEL increasingly relevant for banks and finance companies who realise that traditional supply chains and individuals’ purchasing decisions are more complex and interconnected. Risks are not limited to the delivery of a SME’s products or services (the micro-environment), but, extend to the business as a whole (the market environment) and potentially the world-wide macro-environment, which is where PESTEL starts.
PESTEL is an acronym that stands for Political, Economic, Social, Technological, Ecological and Legal components. There are variations on this, with expanded framework components that include considerations of demographics, culture and ethics.
In focussing on PESTEL, each of the components is made up of several factors that can impact a SME, both positively and negatively, regardless of its size. In working with a variety of SMEs, Business Finance Professionals know that some factors are more relevant than others, and the degree of influence a factor has can change with time.
When analysing the components and their factors, it is important not only to consider the changes that are happening, but also those that are likely to occur. Determining whether a SME will be affected by changes and to what extent is important to both the SME and to lenders as part of their analysis.
The political component considers government activity at a local, state and federal level. At all three levels, general policies, plans and attitudes to economic development, over short, medium and long terms can affect a SME. In addition, consideration needs to be given to non-government organisations and special interest groups that can influence or put pressure on government policy. During election periods, thought should also be given to outcomes such as possible changes in government and whether transitions will be seamless or disruptive to business.
The international political landscape has become more relevant as globalisation opens up new markets and supply chains expand. And there is no question the global political landscape is highly volatile – with both established and emerging countries experiencing uncertainties caused by a range of dynamics across nationalism, populism and the threat of war.
The economic component and its factors of production, consumption and cash flow have a significant influence on SME sustainability, profitability and success. Economic risks can disrupt supply chains and incapacitate a SME. Governments manage economic factors through fiscal and monetary policy, making taxation law and controlling interest rates.
Understanding economic factors is important in positioning a SME for sustainable growth and underpins smart decision-making. Some of the main economic factors that affect a SME include: -
Interest rates: Interest rate risks are relevant to all SMEs, but especially those that have interest-bearing assets or loans impacted by fluctuating interest rates. Lenders are aware of and interested in how interest rate movements/changes will affect a particular SME client or potential client. Interest rates can also have an indirect effect for a SME via changes to consumers’ disposal income.
Exchange rates: Exchange rates are volatile and complex. They have a direct impact on SMEs that are involved in importing and exporting, as changes determine the price of international purchasing. And, like interest rates, they can have an indirect effect, impacting the overall economy and putting pressure on individual consumers’ disposable income.
Recession: Economic recessions (on whatever scale) can alter consumers’ inclination to buy, which in turn can force SMEs to reduce prices or radically modify their strategies.
The social component looks at the SME’s broad market and the attitudes, values and trends of consumers in relation to purchasing the SME’s products or services.
Most social factors are part of one of three categories - Demographics, Societal/Cultural and Beliefs/Attitudes.
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
social class structure
assets of the local population
changes in buying habits
fashion and lifestyle trends
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
beliefs that influence behaviour – e.g. veganism
customs and traditions
banking, investment and saving practices
acceptance of a wide range of people, countries and organisations
interpretation of ethical or immoral behaviours
The influence of technology in the modern world is well known. SMEs now connect with consumers through the internet and social media, and many have adapted delivery mechanisms to suit these new technologies. Indeed, some SMEs would not exist except for the internet.
Integrating new and emerging technologies into a SME can result in significant benefits to a SME and its consumers, and provide the SME with a distinct competitive advantage. The key lies in effective monitoring, assisting SMEs to identify new technology and to alert them to integration issues.
Conversely, technology can pose a risk. Many business leaders have cited a new raft of technology-based business risks, including artificial intelligence, cyber-attacks and data fraud.
Keeping up with technological change is a constant battle and ensuring that technology take-up is advantageous, not cost-prohibitive and not disruptive to a SME’s operations, is easier said than done.
In the PESTEL context, the ecological component refers to the concrete physical environment. In most cases, the environment is difficult or impossible for a SME to control. So, in considering this component, the analysis is about how the SME can quickly adapt and be flexible to meet changing circumstances. Similar to technology advancements, monitoring of the SME’s ecology and environment will enable detection of changes and the ability to promptly put into place appropriate actions. Some of the factors of this component are: -
Weather events and natural disasters can impact on SMEs and globalisation can mean that non-local events have a flow-on effect to a SME.
The impact of climate change may be underestimated due to its gradual rate of change. Notwithstanding, if it results in a shortage of resources, such as energy or water, then SMEs may experience the effects in the longer-term. There is also the suggestion that climate change can amplify the occurrence of weather events that can have an immediate impact on a SME.
Increased pollution levels can affect raw materials which SMEs rely on. And, SMEs that work with overseas suppliers may need to consider regulatory changes to foreign country laws and the impact on their supply of materials.
With increasing pressure on the world’s oil and gas reserves, SMEs that are impacted by price rises as a result of oil shortages may have financial risks to face.
Laws and regulations are used by governments in an attempt to generate a level playing field for society, organisations, businesses and SMEs. They can have a positive or negative effect on a SME and can impact all areas of operations.
Legal risks can affect sales, reputation and business success and can occur even if a SME is aware of and complying with its duties and responsibilities. This can be because third parties and suppliers can be caught up in non-compliant conduct. SMEs who work in the international space also need to cater to foreign policy and laws.
The regulatory landscape is in a constant state of change, which means SMEs must be constantly aware of upcoming and pending changes in law and directives in order to minimise risk.
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