Alphabet's (GOOG 1.44%) (GOOGL 1.89%) Google recently shuttered Spotlight Stories, the VR film studio it established six years ago. Spotlight Stories was initially launched as a partnership between Google and Motorola to create 360-degree videos for mobile devices, and eventually developed VR content for Google's Daydream VR headsets.

The studio worked on several projects with Oscar-winning directors, including Pearl, the first VR film to be nominated for an Academy Award. The decision to close Spotlight Stories wasn't surprising, since Facebook (META -1.38%) closed its own VR studio, Oculus Story Studio, nearly two years ago. But do these studio closures indicate that the VR market, once hailed as the next frontier for tech companies, is in trouble?

Check out the latest earnings call transcript for Alphabet.

Spotlight Stories' "Pearl".

Spotlight Stories' Pearl. Image source: Google.

Spending lots of money on a niche market

Facebook's acquisition of Oculus VR in 2014 sparked a land grab across the nascent VR market. Google's Cardboard and Samsung's Gear VR headsets brought VR content to more mobile devices at affordable prices, while Sony entertained console gamers with the PlayStation VR.

For a while it seemed like the VR market would evolve into a mainstream one, and companies like Facebook, Google, and major film studios poured millions of dollars into the development of VR videos. Unfortunately, the overall market remains a niche one for hardcore gamers and tech enthusiasts.

The PSVR, Oculus Go, Oculus Rift, Gear VR, Vive, and Vive Focus were the six best-selling VR headsets in the world in 2018, in that order, according to SuperData. Yet none of those devices came close to surpassing one million shipments per quarter throughout the year. Shipments of Google's Daydream VR headsets were too low to even mention.

For comparison, nearly half a billion smartphones and over a quarter billion PCs were shipped last year according to IDC. For VR to become a comparable computing platform, headset sales will need to surge over the next few years. Unfortunately, high price tags for high-end models and the disposable novelty factor of cheaper mobile headsets make it tough for VR headsets to gain serious traction with mainstream consumers.

That's why Facebook and Google shuttered their VR studios -- there simply weren't enough eyeballs to justify the production costs of their videos. That's probably why Netflix (NASDAQ: NFLX) never produced exclusive long-form VR content for its platform. Instead, Netflix only launched a "virtual living room" app that lets users view its videos with a headset, as well as short tie-ins to shows like Stranger Things.

Oculus Story Studio's "Henry".

Oculus Story Studio's Henry. Image source: Oculus VR.

Will stand-alone headsets turn the tide?

The closures of Oculus Story Studio and Spotlight Stories don't indicate that Facebook and Google are abandoning the VR market. Instead, both companies are optimizing the form factor of their headsets to reach more mainstream consumers.

Facebook's Oculus Go and the upcoming Oculus Quest are both stand-alone VR headsets that don't require a PC or mobile phone. Lenovo's similar device, the Mirage Solo, is the first stand-alone headset to run Google's Daydream VR.

SuperData believes that Facebook could ship 1.3 million Oculus Quests this year, which would represent significant growth but still fall short of making it a mainstream device. SuperData's estimate could also be too optimistic, since the Quest's $400 price tag matches the price of a gaming console or a mid-range smartphone -- both of which could be more appealing than a VR headset with limited content.

For now, companies seem to be focusing more on AR applications, which enhance real world objects, instead of VR apps. As a result, developers could flock toward AR apps with practical applications instead of immersive VR movies.

A practical decision by Google

Google's decision to stop producing first-party VR films was a smart move, since it could cut some costs and protect its operating margins, which fell three percentage points annually to 21% last quarter. It could also streamline Alphabet's focus on more promising "other bets" like Waymo's self-driving cars and its next-gen healthcare efforts.

However, the closure of Stories still represents a creative setback for the VR film-making industry, which created innovative VR films in recent years. Interest in VR films might rise again if stand-alone headsets gain steam this year, but it's unlikely we'll see higher-budget productions like Oculus' Henry or Spotlight Stories' Pearl again anytime soon.