Microsoft and Google are each prepping for a fight to the death over ownership of users. This SlashDot article discusses the approach each is taking and what the consequences may be for both users and the two firms.
Google has a more clearly defined strategy; the company thinks most applications like email, word processing, spreadsheets, and graphics will be hosted by Google computers, and users will access the applications over an ever fast broadband network.
Microsoft still makes most of its money from software like Windows and Office, which run on the desktop, not from the network. To counter Google, Microsoft has been experimenting with network-based services and applications, but has not had the same success as Google.
The business models are different as well. If you look at Microsoft's net-based services, many of them rely on subscription fees. Google prefers to offer its services for free, although you can upgrade some of them for a fee, which unlocks more features.
For users, the real issue is not where the service resides, but whether or not you can trust a third party with your data. The end user license agreements for free services usually give the firm supplying the services the right to change the terms whenever they want, along with the right to rummage through your files. Google wants to read all your mail and files so it can find out what you buy. They then use that data to deliver targeted ads to you. If Google notices your email includes lots of references to camping, you may see more L.L. Bean ads popping up alongside your "free" word processor.
Hosted services offer many benefits, including access away from the home or office. But I am more inclined to pay for those services. If you want hosted email, why not buy it from a firm like Webmail, which simply provides you with email and is not trying to make a buck reading your mail at the same time?