Final answer:
New entrants in a market can lead to increased competition, thus affecting profitability. Establishing barriers to entry, such as high initial capital costs and brand loyalty, can mitigate the threat posed by potential new entrants and protect profits.
Step-by-step explanation:
In the context of Porter's Five Forces, the threat of new entrants refers to the possibility that new companies may enter the industry, which can lead to increased competition and thereby affect profitability. If a business is profiting, it motivates the expansion of operations or the creation of new ones, making the market more competitive. This process is known as entry. When new firms show up, they may introduce additional capacity and the competition for market share may intensify, often resulting in price reductions and a squeeze on profit margins.
For example, consider an established airline with a major share of flights between two cities. If a new startup enters the market, the existing large airline might slash prices drastically to prevent the new entrant from gaining a foothold. After the entrant fails to sustain their business due to low profitability and exits the market, the incumbent airline can then increase its prices again.
Solutions for businesses facing the threat of new entrants include creating high barriers to entry. These barriers can be in the form of high initial capital requirements, strong brand loyalty among customers, exclusive access to the best resources, or legal and regulatory hurdles. As a result, even if the market is profitable, it may not always entice new firms to enter if barriers are sufficiently high, thus preserving the profitability for existing firms.