They'll be selling on added value, their name and probably simplicity of use. Any website design is likely to be through templates. Initially, their market will be small businesses who don't understand or want to understand the technical stuff AND all those who have had their fingers burnt with dodgy hosts.
I don't think the plan will work if it is just Office on line, but it does seem to be much more than that. If I were a host in this market I'd be very worried. Even if I were doing well with my current customers, I'd expect the number of new customers to slow significantly. And I would expect to lose current customers gradually if I couldn't match the added features from MS.
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