PayPal Inc., whose main business is providing the back-end payment engine for eBay Inc., has added a deal with Paymentech LP to an expansion plan that emphasizes small businesses.
Analysts say the strategy could also be a response to a looming potential threat: free money transfer services from banks.
Starting next year Paymentech will offer PayPal as a payment method for its merchant customers. Paymentech, a Dallas company owned by J.P. Morgan Chase and First Data Corp., claims to handle more than half of all Internet transactions.
PayPal spokeswoman Sara Bettencourt said the San Jose, Calif., eBay subsidiary wants to serve more small businesses and hopes to use its customer relationships as a springboard.
"Many of the sellers that use PayPal to accept payments on eBay also have small businesses off eBay," she said.
PayPal is widely thought of as a person-to-person money transfer service, but its real strength is its core constituency of small-business clients, especially those that market most of their products on eBay and process their payments through PayPal. eBay purchases generate about 70% of PayPal's transaction volume, and PayPal is offered as a payment option on 91% of eBay auctions.
"PayPal's early success is directly related to eBay's success," Ms. Bettencourt said. "We achieved fast growth early on because we met a unique need on eBay."
But now, PayPal, which was founded in 1998 and was bought by eBay in 2002, wants to diversify. It is courting eBay sellers as well as nonauction customers.
In October the company unveiled its first print marketing campaign, advertising in Fortune Small Business, Internet Retailer, Entrepreneur and other magazines targeting owners of small businesses.
Gwenn Bezard, a senior analyst for the Boston market research firm Celent Communications LLC, said the Paymentech deal, announced Wednesday, is "critical." It "gives access to the hundreds of thousands of e-commerce merchants that Paymentech" serves, he said.
That is especially important now, Mr. Bezard said, because banks are moving into PayPal's turf. Since September, both Bank of America Corp. and Wells Fargo & Co. have rolled out free person-to-person money transfer services.
Wells and B of A are positioning their services as a convenient way to send money to friends and family members - they both suggest that parents could use it to send funds to their children at school - and to date neither has given any sign of hoping to capture PayPal's business.
Their services' chief limitation is that transfers can be made only to other individuals within the bank - a Wells Fargo customer, for instance, cannot send cash to a Bank of America customer through this service. Customers can also send money to and from other banks, but only to accounts they own.
E-Trade Financial Corp. and Citigroup Inc. also allow customers to move money between their accounts at different banks for free, and Citi charges a fee for customers to route funds to other people's U.S. or international Citi accounts.
"Potentially, banks could crush PayPal" with their transfer services, Mr. Bezard said.
PayPal has overpowered other online payment providers, including one owned by eBay Inc. Citi shuttered its c2it person-to-person payment system in November 2003, and Yahoo Inc. closed down its PayDirect payment service in October.
With 17.4 million active online users worldwide, PayPal is now the dominant mechanism for person-to-person auction payments. Bank of America has 12 million online banking customers, Wells Fargo has 5.9 million, and Citi has 1.9 million. That adds up to a potential market of nearly 20 million people for the banks' money transfer services.
But Mr. Bezard said that for all its success in the United States, PayPal has sometimes struggled when venturing into other countries - in part because it has had to compete against entrenched bank transfer services.
"When PayPal started to deploy in Germany, they had a rough time, because most people were paying for online auctions using an account-to-account" transfer, Mr. Bezard said. PayPal is "picking up some market share because they are deeply integrated with eBay, but it's only because banks are not really paying attention yet."
Germany is the second-biggest market for eBay after America. PayPal has not disclosed where Germany ranks among its markets.
Mr. Bezard said that to make their online transfer services more formidable, U.S. banks will have to do what their overseas counterparts do - offer transfers to anybody rather than a limited pool of accounts.
"To crush PayPal they would have to deploy an account-to-account transfer ability that offers a lot of the capability that PayPal has," Mr. Bezard said.
In their current form, he said, the banks' transfer services threaten only the 10% of PayPal's volume generated by noncommercial person-to-person transfers, which are free through PayPal. "They don't charge for that, so it's 10% of unprofitable transactions," he said.
Still, that 10% represented $464 million moving between people in just the third quarter, and PayPal uses that free service to attract new customers, Mr. Bezard said. If PayPal loses that business, it could lose that hook. "They want people to be comfortable with it, just to drive usage," he said. "They want to get you addicted."
Avivah Litan, a vice president and research director at Gartner Inc. in Stamford, Conn., said PayPal's focusing on the small-business market is a good move.
"They need to go beyond eBay," she said. "Ninety percent of their payments go to 10% of their enrollees, and those are all small merchants" operating businesses through eBay auctions and sales. "They need to get to the general merchant market."
Banks could find themselves in a tough fight if they take on PayPal, Ms. Litan said.
"There has always been talk about banks threatening PayPal or PayPal threatening banks, and the reason banks haven't pulled it off is banks don't have a big merchant community," she said.
