Cloudonomics: The Business Value of Cloud Computing, + Website

Fixed Capacity versus Variable Demand

In the world of manufacturing, inventory is used to buffer the difference between production and demand. A plant can produce plush toys all year round, warehouse them, and meet the holiday rush. There are carrying costs associated with inventory, but these can be rolled up into the final price, with an optimal trade-off determined between perfect factory utilization and zero inventory.

A “service” is usually defined as something intangible that is consumed and produced at the same time. This is a convenient oversimplification. Various services occur along a tangibility spectrum5; for example, an uncomfortable seat on a long flight (a transportation service) is very tangible, as is a tasty meal at a restaurant (a food service). The criterion of inseparability—that is, that production and consumption occur simultaneously and capacity is thus perishable—is also not strictly true. After all, a tax preparation service or audio transcription service may do its work “offline.”

Generally speaking, however, inseparability and thus perishability are a core characteristic of services. You can’t store cab rides or rental car days or compute cycles in a warehouse for when they are needed.

If there is only so much capacity to deliver a given quantity of services, and demand exceeds that capacity, then customers may queue. However, customers may not want to wait and thus revenue associated with that demand is lost; or customers may be dissatisfied during ...