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

This paper considers firms’ incentives to invest in local and flexible resources when de- mand is uncertain and correlated. Before demand is realized, two firms invest in their local capacity, and provider(s) of flexible resources invest in their capacity. After demand is realized, firms make their investment decision in flexible resource. I find that market power of the monopolist providing flexible 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 flexible 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.