Optimal Pricing and Introduction Timing of New Virtual Machines

As the quality of computer hardware increases over time, cloud service providers have the ability to offer more powerful virtual machines (VMs) and other resources to their customers. But providers face several trade-offs as they seek to make the best use of improved technology. On one hand, more powerful machines are more valuable to customers and command a higher price. On the other hand, there is a cost to develop and launch a new product. Further, the new product competes with existing products. Thus, the provider faces two questions. First, when should new classes of VMs be introduced? Second, how should they be priced, taking into account both the VM classes that currently exist and the ones that will be introduced in the future?

This decision problem, combining scheduling and pricing new product introductions, is common in a variety of settings. One aspect that is more specific to the cloud setting is that VMs are rented rather than sold. Thus existing customers can switch to a new offering, albeit with some inconvenience. There is indeed evidence of customers' aversion to upgrades in the cloud computing services market. Based on a study of Microsoft Azure, we estimate that customers who arrive after a new VM class is launched are 50% more likely to use it than existing customers, indicating that these switching costs may be substantial.

This opens up a wide range of possible policies for the cloud service provider. Our main result is that a surprisingly simple policy is close to optimal in many situations: new VM classes are introduced on a periodic schedule and each is priced as if it were the only product being offered. (Periodic introductions have been noticeable in the practice of cloud computing. For example, Amazon Elastic Compute Cloud (EC2) launched new classes of the m.xlarge series in October 2007, February 2010, October 2012, and June 2015, i.e., in intervals of 28 months, 32 months, and 32 months.) We refer to this pricing policy as Myerson pricing, as these prices can be computed as in Myerson's classic paper (1981). This policy produces a marketplace where new customers always select the newest and best offering, while existing customers may stick with older VMs due to switching costs.