Even though demand response of data centers has attracted many studies, there are very limited attempts on an important segment: colocation datacenters. Unlike large-scale (Google-type) datacenters, the colocation operator lacks control over its tenant servers, which entails a special interest in a design of incentive mechanisms, such that the operator can coordinate tenants to reduce the power usage for demand response. However, most previous studies ignore the role of the demand response provider (DRP), who uses pricing signals as a guide for customer response and as a compensation for their cutting electricity usage. To address this oversight, we propose an incentive mechanism Reward-to-Reduce for colocation’s economic demand response, which shows an interaction between the DRP compensation to the colocation operator, and the colocation operator reward to tenants. Observing that this interaction contains strategic behaviors, we first formulate a two-stage Stackelberg game, where we show a unique competitive equilibrium of the operator strategy in the second stage, and a nonconvex problem of finding the optimal DRP compensation price in the first stage. We next analyze the second-stage equilibrium using an exact analysis and design an algorithm that can efficiently search the first-stage optimal DRP price with a reduced search space. Since the exact analysis can be impractical due to required tenants’ private information, we also propose an approximate approach with limited tenant information. Extensive case studies show that the approximate approach can have the same performance as the exact analysis in a wide array of case studies and the optimal DRP price can be determined effectively, with which the corresponding DRP individual cost is compared with the social cost.