Google is taking the classic business wedge approach. Find a market that is making good money and is related to another market that might make money in the future; then launch a product into the market that's making money and expand into the one that might make money later.
Google can immediately grab some low hanging fruit by approaching businesses first. Their rates for merchant transactions are a full 1% point less than PayPal for all businesses except those doing more than $100,000/mo in processing. They're basically offering the processing near cost and using the service to expand AdWords revenue.
From a business standpoint, that's a terrifically smart thing since their primary profits come from advertising sales and investors will want to see those sales continue to expand.
For business customers, this is also a watershed event. Hopefully it will force PayPal and the regular credit card merchant account providers to reduce their internet transaction fees. The average merchant fee for small and medium sized businesses accepting credit cards through a company like Authorize.net is 2.35% + $.35-50 cents per transaction + a $20/mo gateway fee and a $25/mo minimum processing fee.
Small businesses wanting to sell stuff online should be all over Google's offering. It's cheaper than their bank and cheaper than PayPal. Plus they will see the AdWords thing as free advertising since they'd have to spend that money on the credit card processing fees regardless. So the deal works well in favor of small businesses.
Later, I can see Google expanding and testing the waters with person-to-person micropayments. That market is pretty much non-existent (in terms of a percentage basis) here in the US. Outside the US there is more interest but even in those places it's still in limited stages of use.
For the micropayments business to work here in the US, however, there have to be some fundamental changes to the way the banking system works. The fees to get money on and off of ATM, debit and credit cards are still too high to make business cases involving the handling of large numbers of tiny transactions profitable. Just as any small quick service restaurant (like local sandwich shop) who takes credit cards... they'll tell you how bad it hurts to lose nearly 2% of the bill plus 30-50 cents of every transaction to fees. That's why in many of them you'll see a sign asking credit/debit card users to please make a purchase of at least $5-10 when paying with their cards.