Salesforce and Google Apps are probably the best known software as a service (SaaS) applications, but another early player, Zoho, has been rapidly expanding its innovative lineup of applications beyond the scope of the market leaders.

This week Microsoft confirmed its plans to offer free cloud-based, lightweight versions of its Office 2010 apps next year. Zoho’s suite of businesss/productivity applications has been free for years, but it sounds like that advantage is going to rapidly disappear. For his part, Zoho CEO Sridhar Vembu claims to be amused by speculation Microsoft’s moves are a death knell to Zoho prospects.

“But if there’s anything I’ve learned from my years in the tech world is that companies don’t get killed by competition, they usually find creative ways to commit suicide,” he said in a blog post. “Office 2010 will be the end of Zoho, if we stop innovating, stop being nimble and flexible in our business model. Then again, if we stop all that, Zoho will die anyway, no Office 2010 needed to do the job.”

He correctly points out that Microsoft has a “natural advantage” given its size and installed based. In Zoho’s corner?

” …being nimble and flexible, spotting opportunities and grabbing them quickly,” says Vembu.

He also notes this is not the first time Zoho has faced the prospect of extinction.

“3 years ago when Google entered this market, it was also deemed to be the end of Zoho — now, just how many times are we supposed to die? All of Zoho was about 30 people at that time, and now it is over 300. We have released over 15 new services in Zoho after Google’s entry into the market, and made numerous updates to all our services.”

The power of free

In some ways, Zoho has the same strategic flexibility versus Microsoft as Google does, i.e. not having to protect a $16 billion high-margin revenue stream.

But hey, I think most savvy biz folks will tell you that’s a nice problem to have.

Way, way back in the early ’90s, desktop publishing pioneer Aldus released one of the first desktop presentation programs (originally for the Mac and later Windows). Persuasion was a heck of a program for its time, but it also cost a few hundred dollars. When Microsoft decided to bundle its business apps in an Office suite that included PowerPoint, it was game over for Persuasion.

“It’s hard to compete with free,” I recall Aldus founder Paul Brainerd saying. But these days it seems like free is part of every company’s playbook.