Microsoft Corp launched an updated version of its Office software on Wednesday, aiming to keep its grip on the hugely profitable business application market while countering the challenge of free online alternatives from Google Inc.

The world's largest software company is upgrading its popular Word, Excel, Outlook and PowerPoint applications and rolling out its own online versions to keep up with the new class of mobile, Web-connected users that has emerged since the last upgrade in 2006.

Microsoft announced several improvements on Wednesday, such as editing photos in Word, using video in PowerPoint, collaborating on documents and connecting email contacts to Facebook information.

But the biggest change is Microsoft's move into the cloud -- allowing users to manipulate documents stored on remote servers from anywhere -- where Google has been setting the pace.

Corporate buyers of Office will have immediate access to Microsoft Office Web Apps -- online versions of Word, PowerPoint and Excel programs for Internet-connected phones and PCs -- but will pay more to use them.

Ordinary consumers will be able to use online versions free from next month through Microsoft's Windows Live service, which the company is hoping will entice customers to pay for the full software, which will cost between $100 and $500, depending on the level of features.

The online strategy marks a major shift for the Windows franchise -- with 500 million users according to Microsoft -- which has so far relied on software installed on PCs.

It brings Microsoft into direct competition with Google Docs, stripped-down alternatives to Microsoft's core programs, which are available over the Internet with no need to download software. They are free for personal users and $50-per-user per year for companies. Google says it has picked up 25 million users since launching Docs almost four years ago.

Some analysts worry that the cost of offering online versions will put a dent in the profit of one of Microsoft's two great profit engines.

Margins will fall, but overall revenue and profit will rise as Microsoft grabs a bigger slice of companies' tech budget, said Stephen Elop, head of Microsoft's Business Division, in an interview at an Office launch event in New York.

Margins are lower as a percentage of revenue because we are purchasing hardware and providing services that involve people, said Elop. But most importantly, the absolute profit is expected to go up as a result of cloud computing.

Microsoft's business division, which gets 90 percent of its sales from Office, averages around $2.8 billion profit per quarter. That is 47 percent of Microsoft's total profit so far this fiscal year, second only to Microsoft's core Windows operating system franchise.

Elop said he hopes customer adoption for Office 2010 will be the quickest ever, as companies start to replace aging machines this year and may decide to upgrade to the new Windows 7 system and Office 2010 at the same time. He said 8.6 million people are already using Office 2010 in test versions.

According to the latest data from tech research firm Forrester, 81 percent of companies are running Office 2007, compared with only 4 percent using Google's online equivalent.

A Forrester poll indicates almost a third of existing Office users plan to upgrade to Office 2010 within 12 months.

Shares of Microsoft were up 2.0 percent to $29.45 in afternoon trading on Nasdaq.

(Reporting by Bill Rigby; Editing by Gerald E. McCormick and Tim Dobbyn)

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