Cost Optimization in Cloud Computing: Capacity Reservation for Intermittent Random Demand Surges

The adoption of cloud computing has been accelerating over the last decade, while enterprise cloud users (“firms”) are struggling to manage their growing cloud expenditures in the face of intermittent digital demand surges caused by planned or random events. To deal with such challenges, a firm can employ reserved instances with the standard contract length (e.g., one year) to meet the stationary base demand, which we refer to as the base contracts, complemented by additional reserved instances with either standard or shorter contract lengths, which we refer to as the supplementary contracts, to cope with the demand surges. We first analyze a model whereby the surge and inter-surge durations are deterministic, demand magnitude is random, and cancellation of the reservations is allowed. We develop a capacity management plan for the firm including not only the optimal capacity levels, which follow a newsvendor-type solution, but also the optimal policy for managing the purchase, renewal, cancellation, or expiration of the supplementary contracts, which can be characterized as a two-threshold policy. Due to the complexity of the structure of the optimal policy, we also construct an effective heuristic policy by excluding the renewal option from the action space, which can be applied to a more general setting where the surge and inter-surge durations are random. We examine two model extensions: (1) when trades of reserved instances are allowed in a secondary marketplace; (2) when the firm does not have exact information about the distributions of the surge magnitude and duration while it can adjust the capacity levels as data unveils. Our analysis shows that the optimal policy for managing the supplementary contracts depends on the relative magnitude of the surge and inter-surge durations in relationship to the cancellation fee. Moreover, our numerical results show that cloud platforms that offer a secondary marketplace are more attractive to firms from a cost standpoint than those that allow cancellation only. The latter, without the secondary marketplace, however, can achieve parity with the former by offering a deeper discount rate for the reserved instances, thereby bypassing the cost of administering the secondary marketplace.