Consulting Frameworks in the Toolkit of FP&A: PESTEL Analysis
Many finance professionals at least once in their career had doubts about the efficiency of the external consulting and whether high fees of consulting firms are justified by the delivered insights. These doubts probably stem from the assumption that finance function is usually aware of everything that is going on in the company while external consulting firms initially have no insider information about their clients’ business. Then how is it possible that they can generate effective solutions for any problem their clients face in such a limited time?
Not only have consultants access to a rich knowledge base, but they also tend to use various frameworks which are appropriate to a specific project/mission which simplify problem-solving process. One of the recommendations consultants give to their customers is to identify and imitate existing best practices on the market. Why can’t the FP&A function follow that advice then and adopt tools widely used by their “consulting competitors”? I am not talking about FP&A stealing the jobs of external consultants and fully replacing them. My point is that consulting frameworks should become part of the FP&A tool kit and contribute to the upgrade of the status of FP&A from business partners to trusted internal advisors with proven credibility in business matters.
Working in FP&A for years develops financial intuition about business assumptions and possible outcomes of business initiatives. The use of consulting frameworks can enable FP&A professionals to go from this very “gut feeling” to facts by:
Understanding business from different perspectives and integrating gathered insights into financial models
Identifying meaningful information that matters in a specific business context
Structuring discussions, preparing sound arguments and challenging business leaders
Actively participating in generating solutions to business problems.
Unfortunately, business strategy is rarely or even never taught at schools together with finance disciplines which is one of the reasons why finance and FP&A professionals struggle to win their seat at the decision-making table. However, it’s never too late to learn something new and the adoption of consulting tools can become a shortcut FP&A teams can benefit from to develop their strategic thinking and business skills. This post is the first one in the series dedicated to the use of consulting frameworks in FP&A.
We all know that strategic consulting is historically bread and butter of the top consulting firms. They are hired to help customers make right strategic choices. But companies do not exist just by themselves, they constantly experience influence of the environment which determines the attractiveness of the market and, therefore, has a direct impact on the firm’s profitability.
From one point of view, external ecosystem in which the company operates may put pressure on the organization’s strategic options while from the other – it may offer new opportunities for growth. No wonder, consulting missions often start with external diagnosis to assess the environment and the ability of the company to respond to its current and future threats and opportunities as one of the pillars of building competitive advantages. FP&A professionals should consider as well these aspects in their models and analysis especially when discussing and making strategic decisions.
External ecosystem can be split into 2 levels of influence - macroenvironment and industry factors. In this post I’ll focus on macro-level and specifically PESTEL tool widely used to analyze macroaspects.
Political factors
Political factors which determine how governments and their policies can affect a sector of economy and company’s activities. Some of the examples may include political stability in general, bureaucracy, corruption, taxation and fiscal policies, regulation of competition and anti-trust issues, import/export restrictions, etc.
Let’s take Apple, for instance. During the recent trade war between China and the USA, the latter imposed a 25% tariff on some Chinese-made goods. Apple, highly dependent on its China-based plants, was impacted both in cost and volumes. Samsung, Apple’s competitor, has plants in many countries and can switch from Chinese supply chain to other plants if necessary. Apple could consider diversification of production capacities to decrease possible negative influence of political factors.
Economic factors
Economic factors have direct impact on the economy and, therefore, on company’s performance. These aspects may be represented by economic growth patterns, inflation and unemployment, interest and exchange rates, disposable income, etc. Economic factors can affect supply and demand relationship in the industry and the pricing on goods and services of the particular market player.
Netflix can be a good example to illustrate the impact of these factors. The growth of the streaming services attracted many players to the segment and intensified competition. Increasing subscription fees together with lack of quality content make users opt for other platforms. To keep growing, acquire and retain users Netflix will have to create more original content which is associated with an increasing cost.
Social factors
Social factors include demographical and cultural aspects of the society as they affect needs and buying habits of the consumers. For instance, life expectancy, age and sex distribution of the population, educational level, family demographics, religion and beliefs, lifestyles and attitudes.
Zoom is one of the examples to show how social aspects of the environment influence company’s performance: COVID-19 pandemic boosted Zoom’s growth and performance. Though hybrid work mode is probably going to stay, the blurred boundaries between work and life and lack of social interactions make many users opt for face-to-face communication decreasing the number of paid licenses. This factor may have a huge impact on company’s future performance which is reflected in the next fiscal year revenue estimate with modest 10% growth vs last year.
Technological factors
Technological factors focus on the technological changes, innovation and technological developments, automation, technological awareness and access to new technology, R&D spendings, etc. Technological developments made disruption possible in many industries in which new market players could not only enter the market, but also overperform established existing players.
Uber is a perfect illustration of the use of technological advancements. Uber leveraged technology to enter a conservative taxi market with a mobile app targeting users searching for cheaper transportation options. Playing the innovation card for the second time they entered food delivery segment with Uber Eats which overperformed initial mobility segment deeply impacted by the pandemic. Uber can consider other innovation initiatives and synergies from all its segments in terms of acquisition and retention of their users.
Environmental factors
Environmental factors related to physical environment have recently started to play an important role in the strategic analysis. ESG is now an inalienable part of the business reflected in the strategy of almost any organization. Climate change, carbon footprint, sustainability and other ecological aspects are among the environmental considerations.
L’Oreal example: L’Oreal plans to increase the use of sustainable packaging. They aim that all their plastic packaging will be refillable, reusable, recyclable or compostable by 2025. This initiative will have impact on the company’s expenses in general, product cost, unit economics and pricing.
Legal factors
Legal factors are those related to laws and legislation the firm must comply with. They can impact the environment in which the company operates (for instance, industry specific laws and regulations), as well as directly the organization (for example, patents defend the products of a specific firm but their validity may be limited in time). Changes in legislation should be constantly monitored as non-compliance may result in fees.
Google regularly faces legal issues and illustrates the influence of these factors : numerous fines imposed on Google for breaching data protection, anti-trust and other legislation count billions of dollars affecting their profits on various markets. Considering the frequency of these penalties, the impact of this factor should be included in the forecasting/planning of profits, for example, as contingency reserve in % of revenue.
Here are some ideas on how FP&A teams can benefit from PESTEL framework:
FP&A team members who recently joined the company can perform PESTEL analysis to get a good understanding of the environment in which the firm operates and how exactly this environment influences organization’s activities.
PESTEL analysis is the most efficient as a team exercise, it may become a lever to strengthen business partnering relationships between the FP&A function and business departments of the company. Taken into account rapid changes in many aspects of the external environment, PESTEL analysis should be performed at least once a year.
The insights of the PESTEL analysis should be integrated in FP&A’s core activities, such as planning and analysis, in the form of assumptions and hypotheses or KPIs and metrics. Economic factors are usually included in the financial models as they are easily quantified while other aspects of the macro environment may sometimes be even ignored. ESG metrics should be integrated in the analysis of the strategic initiatives.
Awareness of the cause-and-effect relationships between the external factors and company’s financial performance as well as the ability to estimate the potential impact of various factors give FP&A teams an opportunity and competences to participate in strategic discussions and influence decision-making process.
PESTEL is a powerful tool used by management consultants and marketing teams when considering the launch of new products or new markets. It may be used alone or in combination with some other frameworks to perform more complex and complete analysis. PESTEL is an easy to understand and apply framework that should be integrated in the FP&A’s toolkit to reflect the impact of the external environment while performing FP&A’s key activities.