Risk Management and Optimal Pricing in Online Storage Grids

Abstract

Online storage service providers such as Amazon S3 grant a way for companies, particularly startups, to avoid spending resources on maintaining their own in-house storage infrastructure and thereby allowing them to focus on their core business activities. These providers however follow a fixed, posted pricing strategy which charges the same price in each time period and thus bear all the risk arising out of demand uncertainties faced by their client companies. We examine the effects of providing a spot market with dynamic prices and forward contracts to hedge against future revenue uncertainty. We derive revenue-maximizing spot and forward prices for a single seller facing a known set of buyers. We perform a simulation study using publicly available traffic data regarding Amazon S3 clients from Alexa.com to validate our analytical results. Our field study supports our analysis and indicates that spot markets alone can enhance revenues to Amazon but this comes at the cost of increased risks, due to the increased market share in the spot markets. Furthermore, adding a forward contract feature to the spot markets can reduce risks while still providing the benefits of enhanced revenues. While the buyers incur an increase in costs in the spot market, adding a forward contract does not cause any additional cost increase while transferring the risk to the buyers. Thus storage grid providers can greatly benefit by applying a forward contract alongside the spot market.

Keywords: Online storage, Grid computing, Forward contracts, Market mechanism design

JEL Classification: C44, C51, C52, C61, D42, D81, E37, G13