Enabled by advances in grid and network computing architectures for the delivery of on-demand computing services, the vision of an e-services economy in which computing will be as ubiquitous as a utility is becoming a possibility in business computing. Major firms in the computing industry such as IBM, Hewlett-Packard, and Sun Microsystems are focusing on agility and flexibility of computing resources and gearing up for their own versions of on-demand computing and information technology (IT) outsourcing solutions. The successful introduction of these new computing models requires the development of appropriate pricing mechanisms that are consistent with the enabling technologies. Our paper introduces the notion of contingent auctions to address this lacuna. In contingent auctions, users bid for computing resources in an auction, but are relieved from the contract (paying a penalty) if demand is not realized. We study different mechanisms--ranging from an advance commitment (capacity reservation) to no commitment (pay-as-you-go)--under demand uncertainty. We consider markets in which the demand for computing is uncertain and, moreover, users' value of computing and demand realization may be related. We show how the different levels of commitment affect prices, revenues, and resource utilization under different market conditions. Our results reiterate the need to address the availability-commitment dichotomy in the design of business models for on-demand computing and IT outsourcing.
This paper demonstrates that quality-contingent pricing is a useful mechanism for mitigating the negative effects of quality uncertainty in e-commerce and information technology services. Under contingency pricing of an information good or service, the firm preannounces a rebate for poor performance. Consumers determine performance probabilities using publicly available historical performance data, and the firm may have additional private information with respect to its future probability distribution. Examining the monopoly case, we explicate the critical role of private information and differences in belief between the firm and market in the choice of pricing scheme. Contingent pricing is useful when the market underestimates the firm's performance; then it is optimal for the firm to offer a full-price rebate for misperformance, with a correspondingly higher price for meeting the performance standard. We study the competitive value of contingency pricing in a duopoly setting where the firms differ in their probabilities of meeting the performance standard, but are identical in other respects. Contingency pricing is a dominant strategy for a firm when the market underestimates the firm's performance. Whereas both firms would earn equal profits if they were constrained to standard pricing, the superior firm earns greater profits under contingency pricing by setting lower expected prices. We show that contingency pricing is efficient as well, and consumer surplus increases because more consumers buy from the superior firm.