(July 16, 2008) PayPal Inc.’s multiyear campaign to build up the share of transactions it processes from Internet merchants rather than auction sellers has paid off in a steady rise in non-auction volume to the point that online merchants now account for very nearly half of the processor’s total volume, excluding its gateway business. What the San Jose, Calif.-based company calls its merchant-services business reached $7.26 billion in the second quarter, or 48.6% of total volume of $14.93 billion, according to statistics released on Wednesday by online auction giant eBay Inc., PayPal’s parent company.

Recent signings among large-volume Internet merchants—including several airlines—have helped propel merchant-services volume in the past year. This volume is up 57% since the second quarter of 2007, when it totaled $4.62 billion and accounted for 42% of overall dollar volume flowing through PayPal’s servers. Indeed, just in the three months since the end of the first quarter, that closely watched share stemming from Web retailers grew nearly three percentage points. “That’s a big jump,” says Jennifer Roth, senior analyst in global payments at TowerGroup Inc., a Needham, Mass.-based research firm and unit of MasterCard Inc.

Since April 1, PayPal has announced three major merchant signings, including Blockbuster Inc., Delta Airlines, and Jet Blue Airways. It now claims acceptance at 32 of the 100 largest e-commerce merchants and a 5.1% share of overall e-commerce volume as of the first quarter, up from 3.4% in the first quarter of last year and more than double the 2.3% it notched in the first quarter of 2006. The main attraction for merchants, says Roth, is the steady growth in PayPal’s account base. The company reports 62.6 million active accounts (those that performed at least one transaction in the previous 12 months), up 19% from the second quarter of 2007.

Online merchants are finding alternative-payment systems like PayPal, Google Checkout, and Amazon Flexible Payments can increase a key metric called conversions by bringing in consumers who are prepared to buy, says Roth. In part, she says, this is because the alternative systems don’t require shoppers to type in sensitive information, since this information is already linked to their accounts. “People may not be comfortable shopping online with credit cards but are perfectly happy using PayPal,” she says. “Merchants are leveraging PayPal’s customer base to get at people who are shopping on the Web. These are people who aren’t just browsing but will buy.”

PayPal has been pushing hard for more online-merchant business for the past four years in a bid to diversify its transaction base, which at one time was dominated by eBay’s auctions, a vast marketplace but one whose revenue flows are less predictable than merchant activity. “The more [PayPal] diversifies, the more they don’t have to worry as much about the auctions,” says Roth.

In other operating statistics, eBay reported that PayPal processed 210.9 million transactions in the second quarter, flat with the first quarter but up 26% over the year-ago period. This figure again excludes the gateway business PayPal acquired in 2005 from VeriSign Inc. The processor’s revenue rate was 3.89% of total volume, with gateway revenues included. Transaction expenses were 1.23% of volume, while transaction losses came in at 0.27%, leaving a net transaction margin of 61%.