As I argued in my post Office Generations last year, we're in the early stages of the "hybrid phase" of personal productivity applications, when most people will use web apps to extend rather than replace their old Office apps. This phase will play out over a number of years as the web technologies mature, at which point it will become natural to use purely web-based apps (with, probably, continued local caching of data and program code).

What this means is that Microsoft has a good opportunity to maintain Office's dominance during the switchover by pursuing what it calls its "software plus services" strategy. But Microsoft should be anything but complacent right now. Maintaining market dominance does not necessarily mean maintaining traditional levels of profitability. The biggest threat posed by online alternatives may well be to undermine Microsoft's pricing power - a trend we're already seeing in the student market.