Dashboard For Cost of Construction Projects Course

Macro-environment Forces: 

PESTLE 

The macro-environment includes forces traditionally represented in the acronym PESTLE: 

● Political 

● Economic 

● Social 

● Technological 

● Legal 

● Environmental

Some scholars add another “E,” for ethics, and use the acronym STEEPLE.

The boundaries of these macro-environmental niches are not always clear. The fact is that the macro-environment is extremely dynamic: Changes in one area inevitably have implications in another. For example, government investment in new energy technology will have implications for the economy and the environment. The PESTLE acronym, however, provides a useful checklist for an analyst to review when the time arrives to look outside the organization and its industry.

● Political. Political factors relate to the way in which government policies can affect an organization. This can also include the process of election and transparency about influences on elected officials. Changing government policies can have an enormous effect on business planning and forecasting. Changes in political power can bring new laws and regulations, new priorities (e.g., in spending versus tax reduction) and new philosophies on the role of government and regulation, the use of taxes and levels of public debt. Fiscal policy refers to changes in a government’s spending and tax collection with the goal of improving the economy. Fiscal policy creates both indirect and direct effects on the microeconomy of the organization. The level of stability in the political state is critical, since predictability is an important ingredient in planning and investment.

●Economic. Economic activity refers to the laws of supply and demand and the way the forces of production, pricing, employment, trade, investment and borrowing interact. This is a complex area and merits its own discussion later in this topic. 

● Social. Social factors include characteristics, values and aspirations of society’s members—e.g., demographics, family structures, education and health levels, common problems, religious beliefs, deeply held values, leisure interests. These can all affect a business’s analysis of consumer demand as well as labor supply and cost. 

● Technological. Analysts must understand the technological spectrum: what constitutes “old” technology, what is considered representative of current practices, what could be described as “cutting edge” or innovative, and what technological change lies just beyond the horizon. Then they must be able to place their own organizations, industries and market areas on that spectrum. They must also be aware of technological changes in allied or related industries that may affect their own. And there are other questions to consider. How long can an organization resist a new technology without incurring risks? What is the cost of adapting and at what rate is the cost growing? What unintended problems may the new technology introduce? 

● Legal. The legal environment includes the structure of the legal system and the process for seeking redress and defending oneself as well as the laws themselves. Rule of law is a concept that describes the degree to which a country or community applies its laws equitably and predictably. No individual is above or beyond the law. Rule of law is an important consideration for companies looking to expand in foreign markets. 

● Environmental. Analysts should be aware of current and impending environmental issues that will affect the community, such as shortages of potable water that will limit growth and divert wealth into disease control programs, poor air quality that will affect employees’ health and may trigger regulatory responses, or increased frequency of severe flooding that will increase insurance rates or disrupt production and transportation of goods. As governments, businesses and communities become more aware of environmental threats and sustainable responses, analysts may also be called upon to evaluate investments in sustainable practices, such as certified sustainably built and operated buildings or building technology that conserves fuel consumption or minimizes the use of fossil-based fuels.

Impact of Regulatory Actions 

FP&A professionals must also be aware of new, changed and discontinued regulations from different levels of government that can affect the organization’s financial performance. Regulations can cut across the PESTLE forces. For example: 

● New labor regulations aimed at preventing discrimination, achieving pay equity or ensuring safe working conditions can increase operating costs. 

● Changes in tax laws can affect financing and reporting strategies. Tax incentives for energy projects can make a capital expenditure project aimed at decreasing carbon emissions more promising. An environmental depletion tax can affect a pricing analysis. 

● Health-care organizations may be required to implement electronic health records or payment systems. 

● The results of an options analysis may be affected by environmental regulations, such as emissions limits and carbon taxes or waste disposal requirements.

Analysts should track this information but also rely on their relationships with experts in their own organization—their colleagues in tax, technology, human resource and compliance areas.

Macroeconomics 

Macroeconomics refers to the characteristics and behavior of the economy as a whole—in an aggregated form—as opposed to microeconomics, which relates to the market interactions of individual firms and the effect of price on income and resource allocation. FP&A is concerned with macroeconomics because of the way changes in the economy can affect forecasts and projections for the organization and the entire industry.

The Aggregate Demand-Aggregate Supply (AD-AS) model (see Exhibit I.A.6-1) is based on the work of the economist John Maynard Keynes. The model is often used to plot the possible effects of specific economic events, and for that reason it is a useful way to illustrate the way in which various forces can affect the economy in aggregate.

AD-AS Model Components 

This model of the economy is built on the relationship between the total value of final goods and services produced within specific economic boundaries (e.g., national boundaries)—real output or real gross domestic product (real GDP)—and the price of goods. Price is a weighted average of all the products and services sold in the economy.

Other components of the AD-AS Model include:

● The aggregate demand (AD) line, which shows the output-price relationship in terms of demand. If demand among consumers decreases, prices drop because of increased supply. The output/real GDP decreases. As demand increases, supply decreases, prices increase and output/real GDP increases. 

● The (short-term) aggregate supply (AS) curve, which describes the relationship in terms of output. If supply increases, prices will fall. If supply decreases, prices will rise. (The supply line curves upward because, once past the line of potential output, it becomes increasingly expensive to produce goods because of limited labor and materials.

● The long-range aggregate supply (LRAS), which is the potential output of the economy, what the economy’s workforce can create at essentially full employment. Full employment reflects an economy in which there is only frictional and structural unemployment. Frictional unemployment includes those who are between jobs or perhaps waiting for their first job after finishing schooling. Structural unemployment includes workers who cannot find employment because their skills do not match those currently required. For example, the introduction of robotics in manufacturing plants created structural unemployment for those who previously performed these repetitive manual tasks. LRAS is not related to price, hence the vertical line. However, it can increase (i.e., move to the right) with the advent of new technology or discoveries of new resources. It can also decrease as a result of a sustained lack of investment. 

● Equilibrium, the point at which the economy is producing enough to meet demand, no more or less.

The model can show the way in which different combinations of changes in demand and long- and short-term supply affect price and GDP and produce different economic conditions. Inflation is a sustained increase in the general level of prices throughout an economy. Prices can rise because demand increases while supply remains the same (demand-pull inflation) or because supply decreases (cost-push inflation). Cost-push inflation is often associated with “supply shocks,” the sudden increase in the price of materials or energy. This was seen in the 1973 oil crisis in the U.S. and parts of Europe, and gasoline prices rose by almost 50 percent in one year. Analysts are able to distinguish core inflation from expected volatility by removing volatile food prices and energy from the consumer price index (CPI).

Inflation occurs in two contexts: 

● When AD increases and AS and LRAS remain constant (e.g., because of a decrease in payroll taxes), prices rise. Consumers have more money to spend, but short-term supplies have not been able to grow quickly enough to meet increased demand. 

● When AS decreases temporarily (e.g., because of a fuel embargo), prices rise. Eventually the price increase will drive supplies back up.

Some groups are hurt by inflation while others benefit. Those hurt include: 

● Consumers on fixed incomes 

● Consumers and organizations relying on savings to generate income 

● Creditors

Those who benefit include: 

● Flexible-income receivers (e.g., pension recipients who receive automatic cost-of-living adjustments) ● Debtors

Deflation, a sustained decrease in general price levels, occurs when demand decreases and/or supply increases and LRAS remains the same.

During a recession, falling demand causes GDP to contract for two consecutive quarters. If the LRAS also decreases at the same time, a depression may occur.

A 2008 article in The Economist pointed to two criteria for declaring when a recession has worsened into a depression: 

● A decline in real GDP greater than 10 percent, or 

● Duration of more than three years

Growth in real GDP may be inflationary: Supply increases but demand increases to a greater extent. Prices rise and, with them, GDP. Real GDP growth may also be deflationary: Demand increases but supply increases to a greater extent. Prices decrease with oversupply, but GDP rises because of the increased demand. The goal is non-inflationary growth in GDP—a simultaneous and similar magnitude of change in short-term aggregate supply, long-term aggregate supply and demand. The result is stable prices but increased GDP.

Macroeconomic Effects on the AD-AS Model 

Analysts must be aware of economic movement in supply and demand that can change prices and GDP. These macroeconomic changes have microeconomic effects. For example, the bursting of the housing bubble in the Great Recession lowered the demand for (and price of) housing and also drove down demand for “big-ticket”

household goods such as furniture and appliances. At the same time, decreased demand for energy reduced costs of production. Changes in standard wages, the effect of health-care costs on benefits, an aging population—all of these events in the macroeconomy can potentially affect analyses. 

What macroeconomic changes or events can move the AD and AS curves? The AD line can be affected by changes in:

● Consumer spending. Any factor that affects household wealth will move demand. Lowering taxes will increase net household income and demand for goods. A credit crisis that makes it more difficult for consumers to borrow will decrease demand.

● Investment rates and return. Borrowing for capital investment can be deterred by high interest rates (demand is decreased) or encouraged by low rates (demand is increased). The prospect of a good return on investment will increase investment and demand. The opposite applies as well. 

● Government spending. An expansionary policy calls for greater government spending and/or tax reductions to increase demand and GDP. The opposite effect is achieved through contractionary fiscal policy—lower government spending and/or increased taxes aimed at slowing inflation. Economists differ on the effects of fiscal policy. Some argue that an increase in government spending, so long as it is not accompanied by an increase in taxes and interest rates, will increase demand. Some economists argue that increased government spending triggers increased government borrowing, which “crowds out” other borrowers and decreases demand.

● Net export spending. A rise in net exports creates more demand, and a decline decreases it. Changes in spending might be triggered by increases in GDP or wealth in other countries. Developed economies have benefitted from the expansion of markets in newly developing economies, such as China or Russia. Exchange rates between currencies also affect export spending. A depreciated currency increases exports and aggregate demand, while an appreciated currency decreases exports and demand. 

The aggregate supply curve can be affected by changes in:

● Input prices, which include wages and salaries, equipment and domestic and imported materials and resources. A decrease in costs of production increases supply; an increase in costs will decrease supply. Discovery of new deposits of minerals increases supply. Decreased economic activity during the Great Recession created an oversupply of energy.

● Productivity, which increases output relative to input. New technology, streamlined supply chains and better educated workers can all contribute to greater productivity. This moves the supply curve to the right. In general, global productivity has increased over time, but some social critics argue that a failure to invest in education and workplace technology could result in a less productive workforce.

● Legal/regulatory environment, which can increase or decrease the cost of goods. An increase in taxes increases the unit cost of goods and decreases supply. (The same reaction would occur after a new regulatory requirement added labor and/or materials to production costs.) A business subsidy in the form of a tax rebate or incentive decreases unit cost and increases supply. It is worth noting that there is a difference of opinion among economists about whether deregulation necessarily increases GDP, since deregulation could conceivably lead to increased social costs, monopolies, unfair competition and unethical behavior. For example, deregulation of clean air standards could lead to increased health-care costs and taxes.

Exhibit I.A.6-2 – Business Cycles

 

 

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