Google isn’t a web application company—they’re an advertising company. That’s what they do best, and that’s what drives their company. Of Google’s $23.6 billion of revenue in 2009, all but $760 million of it was derived from advertising, and nearly 70 percent of it was from Google’s own websites.

Everything Google does must be understood within this context. Google builds services like Google Maps, Gmail and Docs and gives them away for free not because they have a philosophical belief that web applications should be free, but rather because giving them away for free gives them a competitive advantage. Free services, running Google ads, are obviously advantageous because free means more people will use them than if they charged and thus they can realize greater advertising revenues.

There’s another reason they don’t charge for their services, though. Since Google’s business is advertising, shifting industries away from paying business models is in their interest. If people are willing to pay for email, mapping and documents, Google’s business model is limited. Thus, using the outsized revenues they make from advertising on search, Google gives away Gmail, Maps, Docs, navigation, translation, et cetera, so no one can compete in those areas—to make free the norm for these services. If Google is giving away a quite good service, it’s hard to compete with them in that area, and so the economics of that business shift away from paid services to advertising-supported. And if a business becomes dependent on advertising for revenue, that’s good for Google, because they’re better at it than everyone else.

Google, though, doesn’t just want to run ads. If that’s all they wanted to do, they could strike deals with other companies to provide ads for their services. That, however, is a risky proposition; a competitor could come along and supplant Google as the leading ad-provider, and they would be finished. So, that’s not Google’s strategy. Instead, Google’s strategy is to weaken other companies’ businesses (say, email) by offering something quite good or good enough for free, take over that market, and then use their new dominant position to rake in advertising revenue.

Android’s Business Strategy

This helps explain Google’s motivation for Android. Google could, of course, just extend their search advertising to mobile phones, Adsense for mobile devices and build mobile versions of their web applications so anyone can use them. That might make for a fine business, but it’d also be a rather weak position to be in compared to where Google is now. Phone makers could change the default search engine on their phones to something other than Google; mobile devices might change how people find information—they might switch away entirely from using a search engine, and in that case, Google would be dead in the water; or, worse, perhaps mobile devices could move people away from using advertising-supported web applications, and toward primarily using paid-for applications; in that case, Google would really be screwed.

So that’s not what Google is doing. Instead, they’ve built an entire mobile device platform and given it away for free. But how are they going to make money from it? All of those things listed above could or are happening—since carriers and phone-makers are free to modify Android, they can (and have) removed Google search entirely from the device; people are increasingly using context-specific applications like Yelp to find information while on mobile devices; and Apple’s App Store, even if it encourages low price-points, has tens of millions of users perfectly willing to purchase applications.

To understand why Google has bet so big on Android, it’s first necessary to understand that mobile devices are the next big growth market. IDC estimates that smartphone sales in 2010 were 270 million units, up from 173.5 million in 2009, and could reach 500 million units in 2011. This is a market growing dramatically, fueled by widespread adoption in the developed world and growing demand in the developing world, where a smartphone’s lower price-point is within reach of billions going forward.

This is important for Google because while Google isn’t licensing Android (and thus doesn’t directly benefit from increased phone sales), smartphones are effectively replacing computers for many people, and thus are upsetting the computer industry. This not only means that Google must be prepared for it—mobile devices mean that Google must adjust their advertising business from its computer-focus—but that it provides an opportunity for them. This is a juncture in the computer industry’s history, and an opportunity for Google to dominate the next big industry, and thus to realize even greater advertising revenue.

Google is building Android not so they can make great mobile devices and sell them to consumers. Rather, they are making them for these two simple reasons: (1) to disrupt Apple’s growing dominance of mobile devices, both so Google doesn’t have to rely on Apple for access to their users and to eliminate their paid-for application model; and (2) so Google can control the mobile industry and thus secure advertising from it.

This helps explain some puzzling moves by Google. For example, Android’s market may not be terrible in comparison to Apple’s App Store for paid applications just because Google hasn’t yet finished it; rather, discouraging paid applications on the Android platform is in Google’s interest. If users won’t pay for applications, what will developers use to make money from their applications? Advertising. And Google conveniently owns one of the largest mobile advertising providers, Admob.

Moreover, why would Google be so willing to empower network providers by giving them so much control over Android? Because it means wider adoption of Android, and as more Android-based devices flood the market, the hardware manufacturers themselves are increasingly irrelevant. As Android spreads, and the differences between different devices decrease as a result, there will be less competitive differentiation between manufacturers—consumers will, like they do in the PC market, shop based more on price than on who makes the device. At that point, hardware will be commoditized, and building a mobile device business based on a different OS than Android will be incredibly difficult. Profit potential will shift from selling actual devices (where margins will be small) to providing services for those devices—quite convenient for Google, who’s in the business of making web services and providing advertising.

This would squeeze out space for Apple in the mass market, forcing them into the high-end of the market, where people are willing to pay higher prices for a better device and experience. This would still be a good business for Apple, but they wouldn’t significantly influence the mobile market’s direction.

Android isn’t an attempt to build the best mobile platform and sell it on its merits; it’s a play to control the vast majority of the mobile market, secure eyeballs for Google advertising and eliminate any threat to Google.

That’s Google’s business, that’s Google’s strategy.

Note: In April, I posted an article on what Apple’s strategy should be.