Competition in the Market for Flexible Resources: an application to cloud computing

This paper considers firms' incentives to invest in local and exible resources when demand is uncertain and correlated. Before demand is realized, two firms decide to invest in their local capacity. Provider(s) of exible resource observe these decisions and invest in their capacity. After demand is realized, firms buy exible resource if demand exceeds their local capacity. I find that market power of the monopolist providing exible resources distorts investment incentives, while competition mitigates them. The extent of improvement depends critically on demand correlation and the cost of capacity: under social optimum and monopoly, if the exible resource is cheap, the relationship between investment and correlation is positive, and if it is costly, the relationship becomes negative; under duopoly, the relationship is positive. The analysis also sheds light on some policy discussions in markets such as cloud computing.