10 predictions about the media industry in the New Year

2018 was a year of massive mergers and acquisitions, with AT&T/Time Warner, Disney/Fox and Comcast/Sky. The #MeToo movement made headlines, and the dominant emotion in boardroom discussions around Hollywood and beyond was fear … lots of fear in the ranks of our tech-infused world of media and entertainment (as well as in the world itself).

So what does the crystal ball predict for 2019?

Here are some of the narratives that will shape the world of entertainment next year and set the stage for the roaring 20s of the media industry.

PREDICTION #1 – Blood continues to spill in the relentless battle amongst premium OTT video giants, as Apple and Disney join the subscription video fray and add to the epic collective assault on Netflix. In the midst of it all, smaller “niche” players either find their singular voices that attract “fandom” and broader monetization, or risk being marginalized and swallowed up by their strategic investors (for a fraction of what they would have commanded a couple years back). 

Originals continue to be the primary weapon used in the premium subscription streaming video battlefront, extending media’s new “Golden Age” for creators and further skyrocketing content-related development and production costs (including the price tags for A-list marquee talent). Fierce premium OTT video competitors increasingly use content both offensively and defensively, like Disney withholding its crown jewels from Netflix (Star Wars, Pixar, Marvel, Princesses, X-Men, Avatar). Netflix feels the heat, as will its investors, as the collective crew of “Netflix-Killers” put increasing pressure on its pure-play business model.

Meanwhile, the newly expanded list of virtual MVPDs (multi-channel video program distributors) fix their initial flaws, offer consumers real competitive choice, and hasten consumer cord-cutting even further.  Whereas we started 2016 with 2-3 real, viable mainstream choices in the U.S. for live television, as of 2019, consumers now can access nearly 10 (cable, satellite, Hulu Live, YouTube TV, DirecTV Now, Sling TV, PlayStation Vue, fuboTV, etc.). And, even in these nationalistic times, let’s not forget about massive international players like Tencent, Alibaba or Baidu’s iQIYI, which went public in the U.S. markets this past year.

Amidst this battle of video giants, several smaller so-called “niche” or segment-focused video players either expeditiously find their uniquely compelling voice and build a fandom-fueled multi-pronged monetizing brand around it, or simply get lost in the noise.

FILE – This June 27, 2015, file photo, shows the Hulu logo on a window at the Milk Studios space in New York. Hulu said Monday, Aug. 8, 2016, that the company is dropping the free TV episodes that it was initially known for as it works on launching a skinny bundle of streaming TV. (AP Photo/Dan Goodman, File)

PREDICTION #2 – Media-Tech driven M&A continues to rule the day in all segments. On the video side, both traditional media companies and undercapitalized and underperforming privately-held new media companies languish in this beyond-crowded OTT video space and become logical M&A targets.

M&A is a hallmark of the overall digital, multi-platform tech-infused transformation of the media and entertainment business. Just like AT&T closed its acquisition of storied traditional (yet slow-moving) Time Warner ($85 billion), Disney beat back Comcast to acquire Fox’s entertainment assets in 2018 ($71.3 billion), Comcast struck back and acquired Sky ($39 billion), and SiriusXM acquired the remaining 81% of Pandora it didn’t already own ($3.5 billion), expect more massive deals in 2019, together with a number of smaller, yet still significant ones. Viacom/CBS is one likely candidate.

And don’t just look within U.S. borders. No virtual wall exists in our borderless new media world, which means that M&A’s pace will accelerate internationally as well. Remember, the Comcast/Sky deal represents a U.S. behemoth’s ambitions to significantly expand its footprint into multiple European territories. Lots of mega-companies around the globe desperately hope to expand their footprints to places where, up to now, they have never been.

To be clear, not all M&A will flow from weakness. Sometimes the numbers offered simply will be too high to reject. But make no mistake. Weakness will abound amidst hyper-competition, and winners will swallow up losers in an environment of accelerating M&A. Many of the so-called niche-focused OTT video services still primarily rely upon ad dollars (especially the younger ones), but remember, Google and Facebook already own about 2/3 of that global digital advertising market. That means that most pure-play OTT video players simply cannot succeed on ad dollars alone. And, for most, other means of monetization will be beyond their reach, as they fail to deliver a sufficiently compelling, differentiated and emotionally connected media experience. So, much like Uproxx did this past year when Warner Music Group acquired it (likely for a song), expect several of the new media players to lose their Indie status.

PREDICTION #3 – The music industry’s streaming-driven turnaround continues and streaming revenues accelerate, but pure-play music services led by Spotify continue to hemorrhage money as losses mount. Meanwhile, the giant “big box” retailers of the day — Apple, Amazon and YouTube (particularly YouTube) — brazenly march on, indifferent to that suffering with their fundamentally different underlying marketing-driven business models. 

Yes, Spotify boasts massive scale. Yet, scale alone does not financial success make. In fact, pure-play growth success leads to higher and higher losses due to sobering industry economics these pure-plays can’t stomach, but the behemoths can due to their multi-pronged business models. These harsh realities mean that investors of many pure-play streaming music services will take a hard look at themselves in 2019 as they contemplate their next strategic next steps. Many will realize that they can’t go it alone. And that leads to more M&A, much like we saw this past year with SiriusXM buying Pandora and LiveXLive buying Slacker. Spotify is not immune here. Unless it successfully expands its business model and drives major new revenue streams, it too could be bought. Facebook anyone?

 

NEW YORK, NY – APRIL 03: The Spotify banner hangs from the New York Stock Exchange (NYSE) on the morning that the music streaming service begins trading shares at the NYSE on April 3, 2018 in New York City. Trading under the symbol SPOT, the Swedish company’s losses grew to 1.235 billion euros ($1.507 billion) last year, its largest ever. (Photo by Spencer Platt/Getty Images)

PREDICTION #4 – Tech-driven media companies thrive and increasingly dominate the entertainment world by using data to their advantage. They use AI, voice and machine learning to dominate further and even more broadly infiltrate our lives and impact our media and entertainment experiences.

Netflix, Amazon and Facebook increasingly mine their deep data about all of our hopes and dreams to maximize “hits” and minimize “misses” as compared to traditional media companies. In many respects, the studios simply can’t compete. Faced with that reality, the quest for data — and the services that provide, analyze and inform – takes on new urgency. Further, the Hollywood establishment and creative community still have yet to understand – at least in large numbers — the power of new cost-effective tech-driven ways to test and measure new characters, stories and engagement in order to more smartly and efficiently place their big expensive bets.

Meanwhile, the new tech-driven media giants hope to increase their overall Media 2.0 dominance through the soothing voices of Alexa and Siri (sorry Google, yours is a little less so) and the overall AI/machine learning revolution. “Virtual assistants,” “smart speakers” (or whatever you want to call them) increasingly dominate our home conversations, improve significantly over time, and serve up our favorite content via “intelligent” recommendations (as well as increasingly targeted and smarter incentives, promotions, ads and goods). 71% of us already use voice assistants at least once per day (most frequently for selecting the music we like to hear), so voice most definitely is here to stay.

More exotically, and perhaps somewhat alarmingly, AI also increasingly drives so-called “intelligent” creation. AI already develops movie trailers that some believe approach the impact of their human-generated counterparts. You be the judge — check out the first AI-produced movie trailer, care of IBM’s Watson, for the fittingly AI-themed 2016 motion picture thriller Morgan. And, just imagine how much AI has advanced in just these past two years since then. Can AI screenwriters be far behind?  Gong Yu, founder and CEO of China’s leading streaming platform iQIYI certainly doesn’t think so. In his words, AI “will reshape the entertainment industry over the next 10-15 years, much more so than the Internet did over the past three decades.”  Just chew on that for a bit.

So, AI may become a real threat even to creative pursuits that, up to this point, most in Hollywood believe are untouchable by computers, bots, and robots. Tesla maven and global futurist Elon Musk is downright dystopian and takes things even further, warning that AI may be an ultimate global threat to us all. Musk tweeted in 2017 that “competition for AI superiority at national level most likely cause of WW3.”   Those were his precise words, so that was either Musk’s particular form of Twitter-speak, or his mind had become a bit hazy during one of his notorious cannabis-fueled interviews!

Amazon is releasing a software development kit that will let developers integrate Alexa into smart screen devices.

PREDICTION #5 – Behemoths Apple, Google and Facebook, together with other tech-driven media giants and deep-pocketed financiers from around the world, increase their already-massive investments in immersive technologies and accelerate mainstream adoption of AR.

AR’s gold rush means continued growth in the related wearables market and consumer adoption of AR-driven eyewear. Investors of all stripes also continue to throw boatloads of cash into the overall immersive space to fuel the development of experiences (including real world live entertainment and storytelling, not only games) to feed these new platforms. Expect significant investment in content. The immersive market opportunity is still so nascent, yet its ultimate promise is so great, that the money working to capture it in 2019 and beyond will seem endless. And, when so much money chases a market, that market becomes our consumer reality.

The onset of 5G wireless networks will only hasten the growth of extended reality (XR) in all its forms. Speaking of 5G …

GUANGZHOU, CHINA – DECEMBER 06: Attendees look at 5G mobile phones at the Qualcomm stand during China Mobile Global Partner Conference 2018 at Poly World Trade Center Exhibition Hall on December 6, 2018 in Guangzhou, Guangdong Province of China. The three-day conference opened on Thursday, with the theme of 5G network. (Photo by VCG/VCG via Getty Images)

PREDICTION #6 – 5G Networks launch, reveal their early media and tech promise and possibilities, and begin to transform our media and entertainment experiences (as well as the overall ecosystem that supports them). 

5G networks are critical for media experiences that require low latency, including AR, VR, and eSports. For AR, 5G reduces the size of consumer headsets, because processing is now done on the network itself rather than on the device. That makes wearables increasingly user-friendly and fuels further innovation and adoption. 5G also accelerates more high quality video consumption on our mobile phones, thereby pushing purveyors of premium OTT video like Netflix to increasingly focus on mobile-first content experiences.

Jeffrey Katzenberg’s and Meg Whitman’s new mobile-driven Netflix-like premium video service Quibi (formerly NewTV) certainly saw this train coming, and jumped on first.

PREDICTION #7 – The oft-overlooked, yet potentially game-changing, live entertainment and event plank increasingly finds itself in multi-platform Media 2.0 strategies, deepening overall brand engagement and monetization possibilities. Expect more significant “offline”-related experiments, initiatives and M&A by both traditional and new tech-driven media companies.

Call this the “Amazon Effect,” as players across the Media 2.0 ecosystem stop scratching their heads about Amazon’s direct-to-theater film releases, brick and mortar retail expansion, and Whole Foods superstore operations – and, instead, increasingly study, respect and emulate them. Netflix certainly did in 2018. After trashing Amazon one year earlier for releasing its features first in theaters, Netflix announced it would begin to do the same.

Amazon understands what most still haven’t even considered – that direct, non-virtual offline consumer engagement may be the most impactful plank of them all, driving online engagement into the real world (and then back again) to create a virtual cycle of daily brand engagement and consumer monetization every step of the way. Even traditional media company Viacom now shows signs of understanding these online/offline brand synergies. It bought both youth-focused video industry conference VidCon and music festival SnowGlobe in 2018.

So, while MoviePass may go the way of the Dodo bird in 2019, movie theaters themselves will not die. They simply will be re-imagined. We humans, after all, are social creatures. We like to get out, and we won’t be satisfied binging on Netflix alone. Movie theater subscription services most definitely are here to stay, and Amazon will offer one soon for Prime members. After all, in a fun fact that may surprise you, more museums populate the planet – significantly more – than McDonald’s. See, there is hope!

ANAHEIM, CA – JUNE 23: General view of panelists at the 7th Annual VidCon at Anaheim Convention Center on June 22, 2016 in Anaheim, California. (Photo by Tara Ziemba/WireImage)

PREDICTION #8 – The #MeToo Movement continues to transform the face (and faces) of both old and new media. And, new faces will invest new industry dollars in new (and frequently very different) content choices, bringing us new (and frequently different) stories and transforming our media and entertainment experiences.

Revelations aren’t over. Abuse was simply far too pervasive. Old players are gone. New, frequently younger, tech-driven media savvy faces get a seat at the decision-making table. They change the game of “what” and “how” we experience content.

Ultimately, #MeToo both cleanses the overall new media industry, and fills our plates with very different media and entertainment choices.

(Staff photo by Brianna Soukup/Portland Press Herald via Getty Images)

PREDICTION #9 – Fake news, fraud and breaches of privacy continue unabated and accelerate, as does marketing concern for “brand safety.”  These seemingly unstoppable negative forces continue to place downward pressure on ad-dependent open platforms. 

Make no mistake, we are in the midst of hacking wars, the likes of which we’ve never seen. This “good versus evil” reality is here to stay, and players across the tech-driven media and entertainment ecosystem either significantly increase their investments in counter-measures and related PR, or risk the wrath of consumers and the overall ad market (much like Facebook did this past year).

Twitter cleaned 70 million fake and automated accounts in a two month span last year (and 1 million more daily), Instagram conceded that over 50% of engagements on its posts tagged as #sponsored are fake, Spotify similarly conceded prevalent ad fraud and decreased its total reported content hours streamed by hundreds of millions of hours, and competing music service Tidal faced accusations that it had falsified tens of millions of streams. Just a few examples of how pervasive fraud and audience manipulation has become in our Media 2.0 world. These fake accounts create, in the words of Variety, “a shadow army of followers that has comparatively little monetary effect. But perform the same manipulation with music streams, and it constitutes fraud.” 

Image: Bryce Durbin/TechCrunch

PREDICTION #10 – Blockchain technology and crypto-currency-fueled investment and experimentation, already over-hyped and under-performing, continues apace. Yet, once again, there will be little to show for it in the world of media and entertainment. At least for now.

Early blockchain leaders continue to be irrationally overvalued, which is always the case with any nascent market. But, on a happier note, the voice of blockchain technology – heard thus far mostly in investment circles with promises of “instant millions” (or even billions) – becomes increasingly heard for its more positive potential for the world of media and entertainment. Blockchain technology conceptually holds revolutionary industry-transforming new offensive and defensive power. On the offensive front, blockchain enables new ways to monetize content via micropayments and direct creator-to-consumer distribution sans today’s leading middlemen. These possibilities begin to reveal themselves in 2019. On the defensive front, blockchain promises to eradicate piracy, but that happens in years, not this coming year.

The bottom line

2019 certainly will push 2018’s Media 2.0 boundaries noticeably further, driven by these and other industry meta-forces. But, these changes will be barely noticeable compared to the seismic shifts to follow in the next ten years.

I close with Paramount futurist Ted Schilowitz’s perspective on all of this. In our conversation, Ted points to two phenomena — the first of which he calls “the known unknown,” and the second he calls “the ten year curve.”  “The known unknown” refers to what he calls the “scary” fact that we all know that massive tech-driven change is coming, but we don’t know the “twists and turns that get us there.”  Meanwhile, “the ten year curve” refers to “big dynamic change waves” that follow ten-year cycles. In Ted’s view, we just recently finished the YouTube and iPhone 10-year cycles, and now essentially everyone around the globe participates in those dual phenomena.

So, what’s “the next big thing?”  Ted calls it the “the evolution of the screen” – so-called “visual computing” via new forms of eyewear (wearables) that replace our smartphones. Think Minority Report-like data and content interaction, and you get the general idea. “Surprisingly little has changed with human/screen interaction in the past 30 years,” Ted points out. He reminds me that while user interfaces have become more sophisticated, actual screen interaction is not massively different — comparing interaction on Mac screens 30 years ago and on iPhones today.

That is all changing right now — as you sit, read and soak in Ted’s thoughts either in print, or more likely on your own v.2019 screen. According to Ted, we are only about 3.5 years into this 10-year visual computing cycle. “In 2013-2014, we saw the first idea of commercializing a track-able screen, a spatial screen. That is a massive change. We will fundamentally change how we use our screens. I see a very distinct future where these things will emerge from their cocoon and replace the iPhone, laptop, etc. You will notice an evolution of 30 minutes per day, then one hour, then two hours, etc.” 

Think that overstates things a bit?  Well, Ted cautions you this way. “It’s the exact same paradigm shift we saw with mobile phones decades ago. Just imagine back then that you would – decades later (i.e. today) — carry a device with you almost every waking moment of your waking life. Even Bill Gates would have said that is ridiculous.”

Yet, here we are. Today. In that “unimaginable” world. That’s how fast it goes.

Ted is adamant about this inevitable “evolution of the screen” reality, and he is convincing. “I know the next evolution is coming. All of these experiments today are on their way to something really, really significant. 2019 will be very subtle in this revolution. Still for the early adopter, because none of these head mounted immersive devices today will replace our smart phones. But the constant and continuous evolution of this tech is happening.

 

Chinese Admiral Wants To "Sink Two US Aircraft Carriers" Over South China Sea

Mere days after Chinese President Xi Jinping vowed to "resolutely" defend China's security interest - a veiled reference to maintaining its domination of the South China Sea - News.au has published details from a speech delivered two weeks ago by one of China's leading military commanders where he outlined a strategy to rebuff the US Navy should it take an even more interventionist posture within the nine-dash line.

Rear Admiral Lou Yuan told an audience in Shenzhen that the simmering dispute over the East and South China Seas could be decisively ended by sinking two US aircraft carriers.

Taiwan’s Central News Agency reported that Admiral Lou gave a long speech on the state of Sino-US relations, where he declared that the trade spat was "definitely not simply friction over economics and trade," but a "prime strategic issue." And that if China wants the US to back off, it must be willing to attack US ships when they intrude in Chinese territory. 

During the Dec. 20 speech to the 2018 Military Industry List summit, Lou declared that China’s anti-ship ballistic and cruise missiles were capable of hitting US carriers, even when they were in the middle of a "bubble" of defensive escorts.

"What the United States fears the most is taking casualties," Admiral Lou declared.

He said the loss of one super carrier would cost the US the lives of 5000 service men and women. Sinking two would double that toll.

"We’ll see how frightened America is."

Lou also explained what he described as the US's five vulnerabilities, and insisted that China must not hesitate to strike back at any of them should a US fleet even dare to stop in Taiwan.

In his speech, he said there were ‘five cornerstones of the United States’ open to exploitation: their military, their money, their talent, their voting system — and their fear of adversaries.

Admiral Lou, who holds an academic military rank - not a service role - said China should "use its strength to attack the enemy’s shortcomings. Attack wherever the enemy is afraid of being hit. Wherever the enemy is weak …"

"If the US naval fleet dares to stop in Taiwan, it is time for the People’s Liberation Army to deploy troops to promote national unity on (invade) the island," Admiral Lou said.

Should Taiwan become increasingly restive, China possesses the capability to stage  a military takeover of the island in 100 hours, Lou said. This eventuality is more likely than many might believe, Lou said, adding that 2018 could be a "year of turmoil" for Taiwan, and that a military conflict was possible.

"Achieving China’s complete unity is a necessary requirement. The achievement of the past 40 years of reform and opening-up has given us the capability and confidence to safeguard our sovereignty. Those who are trying to stir up trouble in the South China Sea and Taiwan should be careful about their future."

"The PLA is capable of taking over Taiwan within 100 hours with only a few dozen casualties," said retired lieutenant general Wang Hongguang.

"2018 is a year of turmoil for Taiwan, and a possible military conflict may take place in Taiwan soon. (But) As long as the US doesn’t attack China-built islands and reefs in the South China Sea, no war will take place in the area."

US military commanders have long warned that China's growing military presence in the Pacific is a serious threat to US security, and China has underscored these concerns by organizing military drills explicitly to threaten Taiwan. Indeed, a military conflict with China remains one of the most widely cited "black swan" risks to global security - a possibility that has only been exacerbated by the trade conflict.

 

Sony/ATV music boss predicts dealmaking surge

Martin Bandier says industry is ripe for consolidation, fuelled by growth of music streaming

Martin Bandier, chief executive of the largest music publisher that controls hits from The Beatles and Taylor Swift, has a message about the frenzy of investment and consolidation in the music sector: there’s more to come. 

The industry is ripe for consolidation, said the chief executive of Sony/ATV, speaking from his office in New York, where figurines of Elvis and Johnny Cash line his desk. 

“There’s been a ton of new entrants,” said Mr Bandier. “There must be 10 new companies that have invested money,” he added, thumbing through an internal presentation and rattling off recent deals. 

“Shamrock Capital acquires Stargate Publishing catalogue, Reservoir Media acquires Isley Brothers catalogue . . . those all happened within the last six months. There’s opportunity here for consolidation.”  

As streaming services like Spotify have fuelled growth in the music industry not seen in decades, private equity groups and other investors have scoured for lucrative copyrights that generate revenue when songs are played in commercials, films and restaurants.  

This means music is back in vogue with investors. Vivendi is looking sell up to half of Universal Music, the biggest record label, to cash in on the optimism. 

Deals so far have ranged from small family-owned assets to the $2.3bn that Sony is paying to increase its stake in EMI, a publisher with more than 2m songs.  

Prices have soared — EMI was valued at $4.7bn in the deal Sony announced in May, more than double that of 2012.  

Mr Bandier said the pricetag reflected frothy valuations across the industry, as Wall Street analysts have inflated expectations. “If you ask Goldman Sachs, they will tell you that the number of [music streaming] subscribers 10 years from now will be astronomical,” said Mr Bandier. “That’s part of the reason that people are spending a lot of money,” he said, citing the sale of Songs, an independent music publisher, for $150m this year.  

The Songs deal was “totally baffling” he said. “What an incredible sum of money for a company that didn’t have a lot in terms of [copyrights]. I can’t point to anything [Songs] had other than The Weeknd.”  

“There were some things [Sony] looked at and thought it was too much money. And then they sold for 15 per cent higher than we had valued it at,” he said, declining to provide examples of assets that Sony/ATV had considered buying.  

Music publishers collect small royalties when their songs are used in films, radio, restaurants and other outlets, offering investors predictable returns for hits that stand the test of time. The pennies add up: Sony/ATV makes revenue of about $600m annually; Mr Bandier said it was on track for its “best financial year yet”. 

Since taking charge of Sony/ATV over a decade ago he has built it from the fourth-largest to the top music publisher in the world, striking deals such as buying out the estate of Michael Jackson to expand Sony’s catalogue. 

Mr Bandier is stepping down in March. At 77, he hints at starting his own venture, but declines to provide details: “I can’t picture myself on a beach, and my golf game sucks. Maybe if I’m out there I can consolidate.” 

AAs digital streaming has revived the industry, music executives like Mr Bandier have been striving to claim their stake of the riches.  

Songwriters have had some victories too. They fought hard in Washington to earn a bigger cut of streaming sales, and won a big pay rise at the start of 2018. 

A US court ruled to give them at least a 15.1 per cent share of the revenues from streaming on platforms such as Spotify, up from the 10.5 per cent rate that was set in 2012. 

However, dealing with Spotify has been “tough” said Mr Bandier. “We always wind up doing a deal [with Spotify], but there’s a lot of friction while we’re in the process,” he said. 

“The music business used to be a relationship business but . . . the power has shifted from the heads of record companies to streaming services. Now it’s important to know Daniel Ek [the CEO of Spotify].”

 

Rewards Credit Cards Gained a Fanatic Following—Now Banks Are Pulling Back

Major perks like airfare and cash back were meant to lead to higher returns. But consumers figured out how to game the system

Blake DiCioccio and her husband, Jason, flew around the world in business class in 2017, from San Francisco to Taipei, Tokyo to Belgrade, and Frankfurt back home. They didn’t pay for it. JPMorgan Chase & Co. did.

The DiCioccios signed up for two Sapphire Reserve cards from the bank several months before their trip, on an offer that scored them hundreds of thousands of points, which they combined with points from their other rewards cards. They use credit cards as much as possible—even for small purchases—and strategize when to use Sapphire Reserve versus their other cards based on the points each offers. Mr. DiCioccio recently signed up for an American Express Platinum card, and the couple is now thinking about canceling one of their Sapphire Reserve cards to avoid the $450 annual fee.

“It’s a game really—like poker,” said Ms. DiCioccio, 34 years old. “Some people come to the table knowing all the strategy and they have the best chance to win.”

The ultra-premium rewards of the kind that JPMorgan has championed have turned into financial albatrosses. Big banks calculated that giant rewards would make consumers spend more, earning the banks more interest and boosting their returns. They calculated wrong.

Consumers have figured out how to game the system, spending just enough to earn generous sign-up bonuses—then abandoning the cards in a drawer. Others pay their bills in full and avoid interest charges and late fees.

After ratcheting up the perks for several years, banks hit peak rewards frenzy about two years ago. Now banks face increasing costs associated with the cards. Rewards costs grew an average of 15% in the third quarter of 2018 from a year earlier at Bank of America Corp. ,Citigroup Inc., JPMorgan, U.S. Bancorp and Wells Fargo & Co., according to bank analyst Charles Peabody.

As of the third quarter, JPMorgan’s credit-card holders had accrued $5.8 billion in rewards they had not yet redeemed, up 53% from the end of 2016, according to securities filings.

“For a lot of consumers, a credit card is the first step in a bigger financial relationship, and we’re already seeing success with Sapphire customers doing more business with Chase,” said JPMorgan spokeswoman Mary Jane Rogers.

Compounding the problem for banks: Interchange fees—paid by merchants to banks whenever customers shop with a credit card—are under pressure.

The fees are a primary source of funding for rewards programs, but retailers are trying to lower them. Merchants including Amazon.com Inc., Target Corp. and Home Depot Inc. are pushing through lawsuits for changes that would lead to lower fees, and bank executives worry that such a shake-up could make some of the more generous rewards programs unsustainable. Merchants paid card issuers $43.4 billion in Visa Inc. and Mastercard Inc.credit card interchange fees in 2017, up 68% from 2012, according to the Nilson Report.

Mercator Advisory Group, a payments consulting firm, predicts that credit cards will deliver a return on assets in 2019 of 3% to 14 large banks highly concentrated in the card business, down from nearly 5% in 2014.

JPMorgan, Citigroup and other large banks, including American Express Co. , are discussing how to cut back or rejigger some of their cards’ rewards, according to people familiar with the matter. The banks don’t plan to end rewards, but want to shift them in ways that encourage more card usage and scale back upfront bonuses, the people said.

Risk and Rewards

Banks face increasing costs from reward cards as consumers have figured out how to game the system.

Rewards costs at five large banks, average change from a year earlier*

JPMorgan Chase's rewards liability†

Credit card return on assets at large U.S. banks

20%

%

5

4Q 2017

$4.9 billion

16

4

FORECASTS

1Q 2018

12

3

$4.9

8

2

2Q

$5.5

4

1

3Q

0

0

$5.8

’15

’16

’17

’18

’19

2Q

1Q 2018

3Q

2014

*Including Bank of America, Citigroup, JPMorgan Chase, U.S. Bank and Wells Fargo. †Value of rewards accrued but not yet redeemed by credit card holders.

Sources: bank filings and bank analyst Charles Peabody (rewards costs); Federal Reserve report (return on assets actuals); Mercator Advisory Group (return on assets forecasts); JPMorgan bank filings (rewards liability)

Getting the calculation right—without alienating customers—is crucial. Credit cards account for an average of about 14% of revenue at Citigroup, Bank of America, JPMorgan Chase and Wells Fargo, according to an analysis by Autonomous Research.

JPMorgan executives debated whether to stop letting cardholders pool together points from multiple cards, according to people familiar with the matter. JPMorgan’s Ms. Rogers said the bank has no current plans to stop cardholders from pooling points.

Citigroup plans to cap the number of times each year its Prestige cardholders who stay at hotels four consecutive nights can get the fourth night free. A Citigroup spokeswoman says the bank is focused on fostering long-term relationships with cardholders.

AmEx has been introducing cards with fewer sign-up bonus points. An AmEx spokeswoman said the company is offering other bonus options, such as statement credits based on restaurant charges.

The banks face rewards enthusiasts who take pride in wringing the most benefits from each card.

For example, many cards offer “tiered rewards,” where only certain purchases qualify for the most generous cash-back terms. That’s no obstacle for customers like Tony Rodriguez, a 34-year-old Ph.D. student in Knoxville, Tenn.

Mr. Rodriguez and his girlfriend, Whitney Forbes, use the AmEx Blue Cash Preferred card for groceries, earning 6% back on up to $6,000 of purchases a year, and for gas, which earns 3%. They use Discover Financial Services ’ “it” card and a Chase Freedom card for purchases that qualify for 5% cash back. Those items change every quarter, so Mr. Rodriguez keeps a list on a slip of paper in his wallet. Everything else goes on their Citi Double Cash card, which gives 1% back on all purchases and 1% back when they pay off the bill.

Mr. Rodriguez, who is studying industrial engineering, began shopping around for cards about 2½ years ago. “Soon, I realized there’s all sorts of free money,” he said.

Big banks pushed into credit cards after the financial crisis to offset a slowdown in their trading and mortgage units. JPMorgan and Citigroup poached top executives from AmEx, which made premium rewards—with a high annual fee—its calling card for decades, and copied the strategy.

Rewards competition began to heat up in 2013 when Discover launched the it card. A year later Citigroup created the Double Cash card, which also offered hefty rewards at no annual fee. Many banks view the rewards as a way to reach younger consumers and turn them into bigger clients by selling them other products, including wealth management services, as they graduate to bigger jobs and paychecks.

Credit Card Report

While credit card openings have leveled off in recent years, consumers are closing cards more often—and banks have pared back on certain rewards.

Share of existing credit cards that were closed

New credit cards opened in the U.S.*

14.7%

66.8

15%

70 million

60

12

50

9

40

30

6

20

3

10

0

0

2013

’18

2010

’17

’11

’12

’14

’18

’13

’15

’14

’17

’16

’15

’16

Average sign-up bonuses on premium rewards cards†

2017

2018

2016

58,000

66,000

44,000

*Not including store-only credit cards †For customers that spent several thousand dollars in the first few months. 2018 data through July

Sources: Mercator Advisory Group (credit card openings and closings); Simon-Kucher & Partners (bonus points)

Merchants also typically pay higher swipe fees on the more generous Visa and Mastercard rewards cards—typically more than 2.1% of a purchase on premium rewards cards, compared with roughly 1.2% to 1.7% on more standard rewards cards.

For the next couple of years, banks competed to come up with increasingly flashy cards. The frenzy reached a peak when JPMorgan introduced Sapphire Reserve in August 2016, offering 100,000 bonus points for consumers who charged $4,000 in the first three months, three points per dollar spent on travel and dining and a $300 credit on travel purchases, among other perks.

JPMorgan’s Ms. Rogers said two years in, the bank had seen record retention levels topping 90% for its Sapphire Reserve customers.

At an investor conference, AmEx called it a “full frontal assault” to its longstanding Platinum card. Despite Sapphire Reserve’s $450 annual fee, customers flocked to it so quickly that JPMorgan ran out of the metal cards and reached its first-year goal for new accounts in two weeks.

Within a few months, JPMorgan had misgivings about the card’s costs. It halved the bonus points to 50,000 and dialed back in-branch promotion of the card.

The Sapphire Reserve card proved great for business for Brian Kelly, who started the rewards website The Points Guy as a hobby in 2010, while working in human resources atMorgan Stanley .

His website helped spawn an ecosystem of rewards fanatics across the internet who swap tips about card deals. The banks covet his favorable reviews of their cards and often turn to the site to promote them. In December, Mr. Kelly hosted a card awards ceremony in New York City, sponsored by JPMorgan, Wells Fargo and others.

JPMorgan had approached Mr. Kelly in spring 2016 to ask how his company would market an upscale card it had in the works. He learned more details about the card, which turned out to be the Sapphire Reserve, a couple of months later while on vacation in Tanzania with his parents. The bank agreed to pay The Points Guy each time readers visiting the website started an application and received the card. The site earned millions of dollars from the card in the months after it was introduced.

Despite misgivings about the rewards programs, banks are still competing for the customers who use them, and chipping away at rewards is risky.

James Fuller of Ellijay, Ga., used to charge about $30,000 a year to his Starwood Hotels & Resorts personal and business credit cards. He and his wife, Allison, used the points to stay for free at hotels in 17 states where they ran half-marathons.

Then Mr. Fuller, a 28-year-old high-school teacher and small-business owner, saw on online forums that the hotel, which was recently acquired by Marriott International Inc., and AmEx might scale back the cards’ rewards. Sure enough, Marriott and AmEx made the cards’ points significantly less valuable last year when redeemed for hotel stays. Mr. Fuller canceled the business card and slashed his spending on his personal card to about $300 a month, from a typical $2,500. 

Mr. Fuller now puts most of his purchases on JPMorgan credit cards.

“We feel confident that the majority of our current SPG AmEx card members will get more value out of the card’s new value proposition,” said an AmEx spokeswoman. A Marriott spokesman said the card remains popular and is “a tremendous value proposition.”

Rob Broadhurst, who lives in West Sacramento, Calif., saw on an online forum that JPMorgan planned to end price protection on Sapphire Reserve. In late March he and his wife, Katie Anderson, hurried to buy a new fridge for $1,599. Weeks later, when they found an online ad for the same model for $1,399, they rushed to submit a claim for the $200 difference, and soon got a check in the mail.

JPMorgan removed the card’s price protection feature in August. “It was definitely a bummer,” said Mr. Broadhurst, 34. The couple still use Sapphire Reserve, though, because they redeem the points for travel.

Banks have been lowering sign-up bonuses on premium cards since 2017, the year after JPMorgan introduced Sapphire Reserve. The bonuses averaged 66,000 points in 2016, before dropping to 58,000 in 2017 and 44,000 in the first seven months of 2018, according to consulting firm Simon-Kucher & Partners.

That is in large part because of concerns many card issuers have about “gamers,” who open cards with rich sign-up bonuses and then stop using them once they have tapped out the early rewards. U.S. credit card attrition rates, a measure of how many cards are closed each year, reached 15% in 2017, up from less than 10% the year before, according to Mercator.

The issue was flagged by AmEx’s then-chief Kenneth Chenault in 2017 when he was asked at an investor conference about competition from Sapphire Reserve. Card companies that are “driving the stakes up,” he said, are “also getting people who are gamers.”

In mid-2017, Krishnaswamy Narayanaswamy, who works in data analytics and is 54 years old, and his wife signed up for J.P. Morgan’s Sapphire Preferred, which included a 50,000-point sign-up bonus. Then the couple, based in Vancouver, Wash., wanted to ditch the card to avoid paying an annual fee—but closing the account, which was in his wife’s name, would have hurt her credit score by reducing her so-called available credit. They also didn’t want to open a brand-new account, which could have impacted her credit score in other ways, like lowering her credit limit. So she transferred to another JPMorgan card that has no annual fee, the Chase Freedom, a move that didn’t technically require closing or opening an account.

Banks are still grappling with how to wean consumers off the easy perks. Barclays PLC this past spring introduced a credit card without a sign-up bonus and instead offered up to 25,000 bonus miles each year to consumers who charged at least $25,000 on the card. Rachana Bhatt, a managing director at Barclays’ U.S. credit card division, said in an interview at the time the bank hoped to appeal to long-term customers with a “sustainable” offer.

The Points Guy website, now owned by Red Ventures, gave the card a lukewarm review.

The card failed to take off. By early October the bank stopped taking applications.

The card “represented a disruptive approach in the industry—rewarding customers for ongoing loyalty rather than just one up-front bonus,” said Ms. Bhatt. “We took a smart risk, learned fast and pivoted.”