In the Five-Forces framework substitutes erode profits because of which of the following factor?

Question

BlackTom AI · Accepted Answer

When examining the Five-Forces framework, substitutes affect profitability primarily by influencing demand and competitive intensity within the industry.
Option 1: 'Manufacturers of substitutes enter markets later and have lower sunk costs' This statement discusses entry timing and sunk costs, which pertain more to barriers to entry and not directly to how substitutes erode industry profitability through demand and rivalry. It overlooks the core mechanism of substitution: shifting demand away and increasing rivalrous pressure.
Option 2: 'Firms producing substitutes use similar worker skills dividing the labor pool' While labor market dynamics can influence costs, this option does not address how substitutes affect demand or the intensity of competition within the industry itself. It focuses on labor supply rather than substitution effects.
Option 3: 'Substitutes compete for similar inputs driving up production cost' This option links substitutes to input competition and higher costs, but the Five-Forces analysis emphasizes demand substitution and rivalry rather than cost pressures from input competition caused by substitutes.
Option 4: 'Substitutes reduce industry demand and drive up internal rivalry' This choice correctly identifies the mechanism: when close substitutes exist, customers may switch to them, reducing demand for the incumbent’s products. At the same time, incumbents fight more fiercely for the remaining demand, intensifying internal rivalry. This dual effect—lower demand and higher competition—explains why substitutes erode industry profits in the Five-Forces framework.
In summary, the accurate description centers on demand erosion and heightened rivalry caused by substitutes, making Option 4 the correct interpretation of substitutes’ impact on profitability within the industry.

In the Five-Forces framework substitutes erode profits because of which of the following factor?

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