Pricing spare resources and options?

[Nomen Nescio]

David Molnar writes:
> The recent comments on Mojo Nation prompted me to look at their site
> again. I don't see much guidance on how to set prices for network
> services. There's a mention someplace that business customers will build
> pricing schemes on top of Mojo Nation, but not much indication of what
> these schemes might be.
>
> So what is the "right" way to price resources? (Preferably beyond the
> obvious "supply and demand.")

In a competitive market, prices will tend to stabilize at the cost to
the supplier, plus profit.  Demand comes in by setting the production
level, which in turn influences costs due to economies of scale and
diminishing returns.  However at least initially the resources supplied
via network services, like storage, will be a small part of the overall
market and so network demand will not affect costs much and we can treat
them as fixed and given.

The price of a network service, then, should be roughly the cost to the
provider based on today's market prices.  This will be derived from the
initial costs divided by the depreciation period, plus ongoing costs.
With disk drive prices dropping so rapidly they probably should be
depreciated in just a couple of years despite the fact that they will
last longer.  So at about $100 for 50 GB for two years the cost would be
$2 per GB of data stored per year.  Then you'd add in your network costs,
divided by the number of users for a per-user cost, and costs of other
fixed equipment like the computer itself, appropriately depreciated.

> A related question - I ran into a friend of mine who had just finished an
> internship in options trading. He suggested it might be worth looking at
> options on spare disk space or other resources, as a means of figuring out
> how to make Mojo-type systems eventually profitable in the real world. Now
> I have a copy of Natenberg's _Option Volatility and Pricing_ to look at...

Generally the purpose of futures and options, in the big picture, is to
allow management of risk.  People can protect themselves against price
changes by transferring the risk to speculators.  (Of course each market
participant has his own motivations, but collectively this is the emergent
behavior which justifies options trading.)

Disk space doesn't seem to be a very good candidate for options because
its price has so far been very stable and predictable.  We don't see
too many price spikes in the disk drive market that someone might want
to protect themselves against.  The prices follow a generally consistent
Moore's law although the exact rate of decline varies somewhat from year
to year.

Similarly, with other computer commodities like CPU and network bandwidth,
price trends are generally stable.  A more promising candidate might be
RAM memory options.  RAM prices has been somewhat volatile over the past
decade and computer manufacturers might benefit from an option market
to purchase risk protection.  But it's certainly not going to be at the
scale of the currency, stock index and agricultural futures and options
which are widely traded today.