updated 6/21/2005 7:30:15 AM ET 2005-06-21T11:30:15

Hoping to build upon the power of its Internet leading search engine, Google Inc. is believed to be developing an online payment system that would pose a stiff challenge to online auctioneer eBay Inc.’s industry-dominating PayPal service.

Industry analysts, merchants and investors were digesting reports Monday that the Mountain View-based company is testing a payment system — codenamed “Google Wallet” — in hopes of rolling out the service later this year.

Google declined to comment, but the company’s silence didn’t muffle the buzz about a service that would set up a showdown between two Internet powerhouses.

Investors, meanwhile, appeared to view Google as a formidable threat. Google’s shares gained $6.40, or 2.3 percent, Monday to close at $286.70 on the Nasdaq Stock Market, where eBay’s shares dropped 81 cents, or 2.1 percent, to finish at $37.24.

“It’s definitely going to happen; too many people already know about it and are talking about it,” said Chris Winfield, who follows Google’s machinations closely as president of 10e20, a search engine marketing firm.

After talking to a variety of industry sources, American Technology Research analyst David Edwards also is convinced Google is developing its own payment system. He believes Google Wallet initially will be tied to Froogle, the search engine’s shopping comparison service.

Google conceivably could use a payment service in many other ways. For instance, the service might process the money that’s exchanged between the millions of merchants and Web sites participating in its online advertising network.

A payment service also could make it easier for Google to sell content through its search engine.

Google already has indicated it will charge visitors to view certain videos that will be indexed in its search engine. Some analysts also think a payment service would enable Google to charge a fee on behalf of publishers looking to cash in on copyrighted or subscription-only news articles.

“This is probably the biggest threat to PayPal that has come along so far,” said Gartner Inc. analyst Avivah Litan.

PayPal spokeswoman Amanda Pires declined to comment Monday. “It’s pretty hard to talk about a product that doesn’t even exist yet.”

The first hint of Google Wallet came in March when the company formed Google Payment Corp., according to documents filed in Delaware. In April, Google incorporated the same company in California.

A move away from online ads?
If the payment-processing service materializes, it would herald a significant expansion for Google, which depends upon online advertising for virtually all of its revenue.

Google’s formula has been highly successful so far, generating a $369 million profit on sales of $1.26 billion during the first three months of the year. But the reliance on advertising has raised fears that Google is more vulnerable to a financial downturn other companies, such as Yahoo Inc., that have developed other revenue channels.

Launching a payment-processing service would help diversify Google because the company would collect a service fee for each transaction it helps complete.

A payment service also might give Google more insights into accountholder buying habits — an advantage that theoretically could be used to do a better job of delivering relevant ad links that would be more likely to be clicked upon to generate more profits.

Although it ranks among the most potent companies on the Internet, Google’s expansion into payment processing wouldn’t be easy, largely because PayPal has such a huge head start in the field.

Since starting in 1999 with just 24 users, PayPal has grown to 72 million accountholders. The service processed payments totaling $6.2 billion during the first quarter, with 71 percent of the activity occurring in eBay’s online auctions.

The service is becoming an increasingly important source of revenue for San Jose-based eBay, which bought PayPal for $1.3 billion in 2002.

PayPal generated $233.1 million, or 23 percent, of eBay’s revenue during the first quarter.

While dueling with PayPal, Google probably would have to spend heavily to combat fraud — a chronic problem for payment processing systems.

“If they don’t do a good job fighting fraud, Google will lose money on this,” Gartner’s Litan said.

Other companies have tried to branch into online payments with little or no success. Sunnyvale-based Yahoo, for instance, ran a service called PayDirect to handle transactions on its auction site, but shut down that free service last year.

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