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Google Apps Turns the 80-20 Rule Into $100 Million a Year

Many people think Google (GOOG) Apps are intended to take a bite out of Microsoft (MSFT) Office . But Google's strategy is wilier than that. Rather than create a replacement, the company employs the Pareto principle -- the famous 80-20 rule -- to produce a product good enough to appeal to most of Microsoft's audience. The strategy has turned Google Apps into a $100 million a year business.

During a Google conference last week, Schmidt mentioned that the Google Apps suite currently has "a couple of million" enterprise customers. Back in March, I noted that the company claimed 25 million people had "switched to Google Apps." Given previously released figures and some common rates of conversion to paid customers in freeemium business models, I estimated that there were between 750,000 and 1.5 million of paid customers. A minimum of two million, however, that would suggest a conversion rate of 8 percent, which is high. At $50 a seat, it also suggests that Google brings in $100 million a year in subscription fees, not counting ad revenue.

Based on these figures, Google Apps would have a difficult time scaling up enough to take the office suite market from Microsoft. To grow the Google Apps business to $1 billion in revenue, the company would need 20 million paid users. At the 8 percent conversion rate, that means a customer base of 250 million people for the free version.

That's a big number, but Google doesn't need that volume for profitability because its development costs are a fraction of Microsoft's. Which brings us back to Schmidt. About eight minutes into his talk, he mentioned something interesting:

Our applications are not full replacements for the incumbents. We're very clear about that; we're very honest about it. And in fact, our strategy for most of them is not to get to 100 percent, but to get to 80 percent. Because if we can get to 80 percent, because of our cost benefit and our flexibility, we think we can provide some real value. And the cost of replicating all of the 20 years worth of development that is represented by the predecessors isn't worth the value, because corporations are moving forward anyway, and you can get enough done with the 80 percent solution.
According to the Pareto principle, 80 percent of people's needs are satisfied with 20 percent of a product's capabilities. If you've ever used any Microsoft Office product, chances are that you've only exercised a small portion of its abilities. Indeed, if that sounds familiar, chances are also good that you've been baffled and overwhelmed by all the Office capabilities you don't need and don't know how to use.

That's where Google sees opportunity. When Schmidt says that Google Apps only needs to provide an 80 percent solution, he might mean 80 percent of the functions of Office, but I don't think so. Instead, I think that Google aims to satisfy 80 percent of Office users. In other words, Google need only provide 20 percent, or maybe even less, of what Microsoft Office can do, which translates into a more simple product and much lower development costs. Google Apps is a business that can scale to profitability even if it only attracts a relatively small part of the office suite market. Smart.

Image: user albion80, site standard license.

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