Final answer:
In the Diamond E-model, competitive rivalry is the key variable affecting industry profitability, influencing how other factors like market demand and regulatory compliance shape the competitive landscape and affect profits.
Step-by-step explanation:
The critical linking variable in the Diamond E-model that impacts industry profitability is competitive rivalry. This model considers various factors that influence the competitive environment and the dynamics of a market structure. Market demand, regulatory compliance, and external factors indeed influence profitability; however, it is the intensity of competitive rivalry that determines how these factors will shape the industry's competitive landscape. For instance, in a market with intense rivalry, factors such as innovation and technology can significantly affect companies' production costs and, subsequently, their pricing strategies and profit margins. Conversely, in a market with less competition, the influence of regulatory compliance on profitability might be more pronounced due to the lack of competitive pressure to improve efficiency.