In many markets, like electricity or cloud computing markets, providers incur large costs for keeping sufficient capacity in reserve to accommodate demand fluctuations of a mostly fixed user base. These costs are significantly affected by the unpredictability of the users' demand. Nevertheless, standard mechanisms charge fixed per-unit prices that do not depend on the variability of the users' demand. In this paper, we study a variance-based pricing rule in a two-provider market setting and perform a game-theoretic analysis of the resulting competitive effects. We show that an innovative provider who employs variance-based pricing can choose a pricing strategy that guarantees himself a higher profit than using fixed per-unit prices for any individually rational response of a provider playing a fixed pricing strategy. We then characterize all equilibria for the setting where both providers use variance-based pricing strategies. We show that, in equilibrium, the providers' profits may increase or decrease, depending on their cost functions. However, social welfare always weakly increases.
The Competitive Effects of Variance-based Pricing