Optimal pricing for cloud service providers in a competitive setting

Cloud services are transforming business and government at an ever-increasing rate. As a form of cloud service, software as a service (SaaS) is one of the fast growing segments of the information technology and has become an attractive alternative to the on-premises software. In this paper, we study the optimal pricing strategies of a cloud service provider in an incumbent-entrant setting under user upgrade cost and switching cost. Our results show that in equilibrium the market structure is not unique. The specific market segmentation depends on the incumbent's pricing strategy whether to provide discounted price to its old customers and the levels of user upgrade cost and switching cost. When faced with customers who are heterogeneous in the sensitivity to the related costs, the incumbent firm may need to offer a discount to the new customers rather than to those who have purchased from it. This implies that the entry of a SaaS firm into the market is a potential threat to the incumbent on-premises software firm, especially in capturing new customers from the untapped market.