Many tech companies believe that virtual reality represents the next major market after smartphones and tablets. In an interview in the German newspaper Die Welt am Sonntag earlier this year, Facebook (NASDAQ:FB) CEO Mark Zuckerberg called VR "the most promising candidate" for a "new computing platform." Piper Jaffray estimates that sales of VR headsets could top half a billion by 2025, and tech M&A advisory firm Digi-Capital claims that the VR market will grow from nearly nothing today to $30 billion by 2020.
However, investors should read those rosy forecasts with a grain of salt. Virtual reality has been hailed as the "next big thing" for decades, and analysts often overestimate the growth potential of new tech markets. Smartwatch forecasts, for example, were quickly reduced after Apple Watch sales fell short of expectations.
Therefore, let's take a contrarian look at the VR market, spot its biggest weaknesses, and see which companies could be hurt the most if it doesn't become the next computing platform.
Why VR devices could flop
Facebook and Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) Google have been trying to broaden the appeal of VR with camera rig partnerships and 360-degree videos. Facebook targets the high-end gaming market with the $600 Oculus, which needs to be paired with a $1,000 computer. Google targets the low-end market with Cardboard, which works with most modern smartphones and has paved the way for its new mobile-based platform, Daydream, to enter the market.
The problem with Facebook's strategy is that it relies very heavily on PC gamers upgrading their computers to "VR ready" specifications. A survey by Valve last year found that less than 20% of its 2,000 respondents planned to buy a new computer for VR games. Even fewer gamers wanted to move their PCs to a different part of the house, like the living room, so they could play VR games in an open space. Another survey by research firm Vicon found that a third of respondents thought that the high price tags of headsets and VR-ready PCs would be "the biggest challenge" for the VR market to overcome.
That might make Google's low-cost approach seem smarter, but another recent survey by Horizon Media found that two-thirds of 3,000 mainstream consumers in the U.S. didn't even know that VR headsets had been commercially released. Meanwhile, 55% stated that they didn't want to own a VR device because it wasn't "interesting or exciting", and 34% said that if they wanted to have experiences, they would "just go do them in real life." Lastly, there's the "geek factor" associated with VR headsets -- which prevented Google Glass from becoming much more than a toy for hardcore techies.
A reality check for VR's true believers
If the VR market doesn't live up to expectations, several companies could be in for a rude awakening. Facebook could fail to recoup the $2 billion it spent on Oculus two years ago if it doesn't sell enough headsets to create a revenue-generating software ecosystem, for example. But Facebook would likely bounce back from that defeat, since nearly all of its $17.9 billion in revenues last year came from advertising. The same can be said for Google.
Sony (NYSE:SONY) could feel more pain, since it's counting on PlayStation VR to boost sales at its gaming division, which generated 19% of its sales and 30% of its operating income last year. In addition to boosting hardware sales on its own, the PS VR could increase sales of the upcoming 4K-capable "PS4 Neo", which will reportedly be optimized for VR games. If the PS VR sells poorly, Sony's plans for refreshing its console sales could crumble.
GoPro (NASDAQ:GPRO), which is counting on sales of VR rigs and a possible spherical action camera to boost its slumping sales, could find that the TAM for VR capture devices is much smaller than it anticipated. HTC, which recently earmarked $100 million for investments in VR start-ups, could suffer if the Vive fails to offset slowing sales of its smartphones. Samsung probably won't be hurt as much as HTC, since it has a much more diverse portfolio of products, but it could lose a potential stream of revenue if its Gear VR headsets don't interest enough of its smartphone users.
But don't dismiss VR altogether
I'm not saying that the entire VR market will crash and burn. Indeed, only 2% of respondents in Vicon's survey believed that VR devices would be "a complete flop." But investors should consider all these facts before blindly assuming that VR headsets will replace smartphones as the next big computing platform. They could remain niche devices for years to come, and companies that stake too much of their future on the VR market could be badly burned.