AMD (AMD -0.98%) often cites the growth of the virtual reality market as the next big catalyst for its GPU and semi-custom SoC businesses. The logic is simple -- demand for its cheap low-end "VR ready" GPUs for PCs will grow as headsets like the Oculus Rift and Vive become more popular, while upgraded consoles for VR titles will bolster sales of the semi-custom SoCs it provides for the Xbox One and PS4.

Many analysts concur. Last year, Canaccord Genuity analyst Matthew Ramsay noted that the "emergence of VR and 4K content" would hasten the console upgrade cycle, and "serve as a benefit to semi-custom volumes for AMD." But before investors put their faith in AMD's potential growth in VR, they should consider the possibility that analysts might be wrong about the VR market's future.

A woman wears a VR headset.

Image source: Getty Images.

The virtual reality niche

Despite the widely hyped launches of Facebook's (META -0.54%) Oculus Rift, HTC's Vive, and Sony's PlayStation VR last year, the virtual reality market remains a niche one. According to SuperData Research, 6.3 million VR headsets were shipped last year. That's a paltry figure compared to the 57.9 million PS4s and 29.5 million Xbox Ones that have been shipped so far.

Samsung dominated the market with 4.5 million shipments of its $99 Gear VR, which is paired with is high-end devices and tethered to Facebook's Oculus Home ecosystem. All of the other pricier headsets sold fewer than 1 million units.

The relative popularity of the Gear VR is troublesome for AMD, because the device doesn't require any of its chips. Instead, the headset is powered by Samsung and Qualcomm's mobile chips within the paired smartphones. Meanwhile, the $500 Rift and $800 Vive -- which are both tethered to pricier, high-end gaming PCs -- remain too expensive and cumbersome for mainstream consumers.

NVIDIA's low-end assault

AMD initially impressed gamers last year with the RX 480, a $200 card which was the cheapest "VR ready" GPU on the market. But that victory was short-lived -- NVIDIA (NVDA -0.62%) subsequently launched the GTX 1050 Ti, a $140 card which was also dubbed "VR ready" by Oculus.

AMD's RX 480.

AMD's RX 480. Image source: AMD.

The GTX 1050 Ti -- along with non-VR ready cards like the GTX 1050 ($109) and GT 1030 ($80) -- mark a major escalation of the ongoing price wars between the two GPU makers. These battles will inevitably lower the price of "VR ready" GPUs over the next few years and dull AMD's competitive edge.

The rise of stand-alone headsets

Another troubling shift is the current movement to cut both smartphones and PCs out of the VR loop. Facebook and Alphabet's Google both recently revealed plans for stand-alone VR headsets that don't require PCs.

If these companies remove PCs from the VR equation, it's likely that sales of "VR ready" GPUs will decline. AMD might offset that decline by leveraging its reputation in gaming consoles to sell custom SoCs for those VR headsets, but it could still face tough competition from NVIDIA -- which currently supplies the Tegra SoC for Nintendo's (NTDOY -0.57%) popular Switch console.

Nintendo's Switch console.

Image source: Nintendo.

Nintendo's use of the Tegra indicates that NVIDIA's chip provides plenty of graphical horsepower in a small, tablet-sized package. NVIDIA's VRWorks SDK (software development kit) for VR developers also directly counters AMD's similar SDK, LiquidVR. As a result, AMD might not dominate stand-alone VR headsets in the same way it did with current-gen gaming consoles.

Should AMD investors worry?

Tech M&A advisory firm Digi-Capital estimates that the VR market could be worth $25 billion by 2021, while many companies and analysts believe that VR could be the next big computing platform. While that could still happen, investors should keep an eye on several key trends.

If the mainstream adoption of higher-end VR headsets doesn't accelerate this year, the VR market could remain a niche one. If smartphone-based VR headsets continue outperforming PC-based ones, companies like Samsung and Qualcomm would benefit more than AMD.

If stand-alone headsets alter the market, AMD could become locked in a tough SoC battle against NVIDIA -- which mirrors the two companies' current battle in PC-based GPUs. Therefore, AMD investors shouldn't panic, but they should take any claims that VR will be a huge growth catalyst with a grain of salt.