Yes, I am being forced to evolve my belief that Google would never be so dumb as to compete with Microsoft's core business. I continue to believe--and I think the purchase of Upstartle bears this out--that Google is smart enough not try to take down Redmond by persuading corporations to switch to Open Office. But it does seem undeniable that Google views its competition as Microsoft (and, therefore, the tech industry) instead of Yahoo! and the media industry.
This said, some of the jubilant "Redmond is toast!" rhetoric that followed the Writely buy ignores a few points. To wit:
Microsoft makes the vast majority of Office revenue from corporations, governments, and other organizations, not individuals. Although there is undoubtedly a market for personal office productivity tools--a portion of which might be interested in a free, web-based alternative like Writely--this portion is comparatively tiny. This is important because most corporations are not going to allow (much less encourage) employees to use web-based tools to create job-related documents unless and until they are certain that all issues regarding security, reliability, ease-of-use, storage, and compatibility have been resolved. One reason Microsoft has continued to make hay with Office even with the existence of Open Office and other alternatives is that corporations have more important considerations than "free."
Next, of the small percentage of the office-productivity market that is looking for cheaper, personal solutions, the fraction that really care about FREE already has plenty to choose from. They can download Open Office, for example, or boot up WordPerfect. The reason these products have not made a dent in the Word monopoly is not that they suck (although many do). It's that 1) no one else uses them, creating compatibility headaches, and 2) that Microsoft Word just isn't that expensive relative to the value it creates.
Third, let's assume that Writely is in every way the equal of Word and that no Writely user will ever buy another copy of Word. How is Google going to make money from this? AdWords? AdSense? Probably not. No self-respecting professional is going to tolerate ads inside documents, and if Google tries to stick them somewhere in the browser, click rates will likely be low (when you're writing, you don't waste time clicking--one reason email ads don't make much). Display advertising? Again, probably not. The trade off between paying $100 for an ad-free word-processing environment and having your screen look like a NASCAR hood is one few corporate users will make.
So then subscriptions? Maybe. But if users are paying money anyway, why not pay it to Microsoft--especially if/when Office Live delivers its own web based solutions. Unlike Google, Microsoft really knows what it's doing in this arena. If both are going to charge me, I'm not going to be in a hurry to switch.
No revenue necessary? Google Word will just be a hook to bring in users and keep them on Google all day? Well, maybe, but it's hard to see the value in this, especially when there is such a gigantic amount of money to be made in other areas of Google's business. Google is already spending way too much on CAPEX, and some day, when the stock's in the tank, they will presumably cut back on revenue-less storage hogs.
One thing that's for certain is where the revenue is NOT going to come from, and that's where Microsoft's comes from: Out of Fortune 500 technology budgets. Unless Google radically--and I mean radically--shifts its focus, it is not going to be persuading Fortune 500 CTOs to rip out Microsoft anytime soon. The enterprise software business--the business Microsoft, IBM, Oracle, etc. compete in--is completely different than the business Google competes in (media). As Microsoft itself has learned--the hard way--the media and enterprise software businesses require different salespeople, different client contacts, different value propositions, different budgets, different everything.
Another thing is for certain: Yahoo!, AOL, Time Warner, and the rest of the media world would like nothing more than for Google to go charging off on an Ahab-like quest to harpoon the Redmond whale--because the vast resources this would require would almost certainly weaken Google's chokehold on the search business. Even Microsoft is probably salivating at the thought that the Google guys will become so obsessed that they take their eyes off their crown jewels.
So, yes, it has become undeniable that Google has its heart set on giving users a way to write documents, maintain calendars, and do email. What is less clear is why.