The U.S. General Services Administration (GSA) awarded a five-year, $6.7 million contract to Google and Unisys Corp -- a relatively small dollar amount but an important initial foothold.
As part of the contract, Google and Unisys will transition the GSA, which basically serves as the back office for federal agencies, to a secure cloud-based platform that includes Google's Gmail, Calendar, Docs and Sites applications.
GSA is the first U.S. federal agency to make a agencywide "move to the cloud."
Cloud computing is computing over the Internet, in which applications are delivered through a web browser, allowing any time and anywhere access to information.
Consumers typically use cloud computing when online banking or shopping on sites like Amazon.com.
The GSA is a big win for Web search engine leader Google because the agency touches so many aspects of the federal government, potentially setting the company up for other federal agency contracts.
"It's a real duel," said Melissa Webster, program vice president for content and digital media technologies at market researcher IDC.
"Microsoft is clearly in Google's gun sights and... Google is a huge threat to Microsoft in lots of areas," she said.
She added that the biggest challenge Google poses to Microsoft is on pricing.
Software giant Microsoft expressed disappointment in the GSA's decision. However, Microsoft U.S. Public Sector Vice President Curt Kolcun said in a statement the company remained "gratified that so many federal, state and local governments have chosen Microsoft to meet their business needs."
But Google hopes the GSA win will begin to change that.
"This opens up the flood gates to a lot of agencies who really have wanted to move to the cloud and have wanted to see a green light to do so," Dave Girouard, Google's president of enterprise, told Reuters.
Girouard said Google's advantage over Microsoft in cloud computing hinges on the elimination of software installation as Google's cloud is entirely web-based, keeping prices low.
"We're built from the bottom up for the cloud. That gives us a significant head start over Microsoft," he said.
Microsoft said competition was good for the industry, and it was confident customers would not stray.
Microsoft offers a "private cloud" option that hosts its products on the customer's own servers. Google's servers must host their suite of cloud services.
Moving all of its 17,000 employees and contractors to cloud-based email and collaboration tools will lower costs by 50 percent, saving the agency $15 million over five years, GSA said in a statement.
"I think other agencies will look closely at that savings as budgetary pressures become more and more significant in the federal government," David Mihalchik, Google strategy and business development executive, said in a phone interview.
With Google Apps integrated into government operations in more than 30 states, in addition to use by more than 3 million businesses, Mihalchik, who oversaw the GSA contract process, said he expects to see the same kind of strong adoption in the federal market.
"We're offering a more powerful technology at a lower cost with better security," he said.
Global IT spending on cloud services are expected to triple by 2013, topping $44 billion, IDC said.
IDC's Webster said that although a cloud vendor offering robust functionality could displace the incumbent, she did not think Google would be able to displace Microsoft in the private sector.
"There is still a huge gap in what Microsoft provides in its online suite and what Google provides," she told Reuters.
"The real threat to Microsoft is to maintain its price and maintain its value in the face of this cheaper, innovative challenger," Webster said, adding that the heated competition with keep prices down for consumers.
But Google may make inroads in the government sector, she said, as these deals are driven primarily by email services.