As Lee begins to open up more about the types of companies being created at his incubator, Innovation Works, there’s a consistent theme—Android. Whether it’s address books, music programs, video games, maps, eCommerce marketplaces or e-readers, many of Lee’s companies are hoping to take advantage of the good things about Android—namely that it’s a free, robust operating system—but customize the core smartphone applications in a way that Google won’t or can’t.

It’s interesting that I had a conversation with Lee about this topic right about the time Google CEO Eric Schmidt was delivering a keynote touting that more than 200,000 Android-powered smartphones are activated daily, going beyond just the smartphone wielding “elite.” Lee would agree with everything his former boss said. It’s just that Google isn’t well positioned to make money off the apps and services in the world’s largest market. Oops.

Lee philosophically may have issues with the lack of openness in the Chinese Web, but it’s also giving him an advantage: The most popular applications for the Android phone like YouTube, Facebook, Twitter or Pandora aren’t available in China, and Google’s native apps may not be the top choice of manufacturers given the search engine’s stance on doing business in the country. So Innovation Works is collectively trying to build a new Web on top of the platform that’s customized for Chinese tastes.

For example, music services that show song lyrics as they play—an essential feature for China’s karaoke loving audience. Another example is a program that automatically enters different dialing prefixes that save money on calls to certain regions. Because 3G is so expensive in China, a video program called Wonderpod downloads videos onto your phone from your laptop at work, so you can watch them without having to stream them on the commute home. An eReader software company lets you read 60% of the book for free then asks for a payment to read the rest. Because of rampant piracy, there’s no chance of selling eBooks without giving anything away for free, but once people are hooked, if they enjoy it, they’ll pay for the rest of the book out of convenience, Lee argues. The incubator is making a few, broad platform plays with an Android-based operating system called Tapas, an analytics tool for developers called Umeng and Ascending Cloud, a publisher of social games.

At most, Lee’s mobile companies are getting a couple dollars per user for these apps so these ideas only become huge companies with massive scale. This can’t be just a game played for the top of the pyramid. And there’s no question in Lee’s mind that Android will be bigger in China than the iPhone, because the cost differential is much more pronounced. Because there aren’t many Android models in the US, hardware makers can price the phones close to the iPhone, but in manufacturing-heavy China prices will almost certainly be driven down much faster.

Lee says the Android devices coming out next year—including manufacturers his companies are working with—cost $200 to $300 per phone. He expects that to fall to around $100 the next year, and possible fall below $100 the year after that. The iPhone will never experience that kind of competitive pressure because only Apple makes it. (Although I could show you plenty of cheaper versions with the an Apple-like logo in the dodgy markets of Shenzhen…)

And there are no carrier subsidies in China, because 80% of phones are bought independently from airtime. So an iPhone will cost around $600. Already Android will enter the market at half the price. For a big swath of the Chinese population that will make a difference, especially if those prices can get under $100 per phone in just a few years with features more tailored for the market.

In a lot of ways, this is a strategy that would only work in China—it’s all about volume and counts on a market with hyper-aggressively competitive gadget manufacturing. But with billions of dollars in venture capital sloshing around China, the market to build the best mobile apps could be as cutthroat as the competition to win the hardware wars. Lee has recently inked some strategic partnerships with Foxconn, Chunghwa Telecom, MediaTek Inc and a raft of global investors to help his chances of being the one to profit from the opportunity.

He’s also moved Innovation Works from Google China’s building to a new location that features what any incubator needs—a hologram that greets you at the front door. I’m not kidding. He told his designer he needed it to look different than any other office and from the look of the pictures, he succeeded. His mobile bets are less certain. But if he wins he’ll have at least one guy to thank: Sergey Brin. A big juicy market opportunity is a lot better parting gift than a watch.

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Authors: Sarah Lacy

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