You are right. Google earns money by being, in their own words, the largest advertising agency in the world. They control 40% of online advertising by many estimates. Adsense is only one of their products, it is the one everyone is aware of. But they own products that do more traditional banner/flash advertising, plus products for games, videos etc.
If you read their quarterly report this week, it is all about the ad systems and a little bit about what they are doing with the applications.
There's a reason why google has moved more and more into content (books, news etc.) and that is that it allows them to get ALL of the advertising dollar (well apart possible from ad creative), rather than being just the intermediary. Applications have the same purpose. I am not sure how competing with your customers will work out in the end, but I think they certainly can get away with it.
This is of course the advertiser's wet dream: you get people to spend hours a day on a platform where you control the message. You know what they search for, what they read and write about, what they are working on - and you control the means by which they do all these things and control the messages they see. Imagine going to a widget maker and saying "i can get your ad in front of people who are searching about widgets, but at a higher rate i can get it in front of people who are emailing about widgets, or have received an email about widgets, or are reading a document about widgets, or are writing a memo about widgets." Clearly that is sexy.
But google are going one step further and they are talking about brand message control. And that is worth billions because corporations are totally paranoid and scared witless about the web. Marketing used to be all about message control and they have lost that control... Saying "you can use adsense premium to make sure your message appears on the google ads of any site which might have comments or content criticising your product" - that's print-your-own-money territory. They are not quite there yet (only available on google's own sites atm) but this is where they are going and investors certainly seem to believe they will get there.
Google needs things like the summer of code and supporting open source and giving away products for free - because with their size and dominance they could overnight become "the big bad monopoly" in a lot of people's minds.
I must say i dont have a google account, because I don't like my data in the hands of advertising agencies. My data is mine and I dont want it mined and sold, not unless I get some money for it. I know the tools are good and whatnot, but I prefer to pay for my email and have a) a contract that gives me rights over my own data b) a supplier whose livelihood depends on delivering me the service i want, not selling my eyeballs
But then I never trust or like the dominant brand in any field, thats just me...
Also I suspect that a lot of the things in google labs are not being done because of income potential (some are) or not even for image/buzz, but simply to attract and more importantly retain talent - working on the same products gets old and things like encouraging pet projects means people might stay when they might have moved on. And even that hasnt prevented them from losing quite a few of their search engine specialist talent to new startups, which is a mix of economic reasons (the get-rich years are over) and technical (google is not pushing the envelope in search anymore)
