Over the past few years, AMD (NASDAQ:AMD) has struggled with losing market share in the x86 and graphics chip markets against rivals Intel (NASDAQ:INTC) and NVIDIA (NASDAQ:NVDA). To avoid directly competing against those two market leaders, AMD has expanded into smaller niche markets.

Two such markets are augmented reality (AR) and virtual reality (VR), which AMD highlighted as "key drivers" of future growth during its analyst day in early May. AMD stated that the AR and VR markets could grow from nearly nothing today to $150 billion by 2020, citing research firm Digi-Capital's estimates. 80% of that revenue is expected to come from AR devices, while the remaining 20% will be attributed to VR ones.

Source: AMD.

Will AMD really profit from that growth, or is it merely pegging its name to a hyped-up fledgling market?

Why AMD believes in AR and VR
AMD believes it can naturally evolve its presence in the gaming industry into the AR and VR markets. AMD's APUs (advanced processing units) combine CPUs with GPUs (graphics processor units) on a single chip, making them ideal all-in-one solutions for devices that require heavy graphical processing horsepower. Sony's (NYSE:SNE) PS4 and Microsoft's (NASDAQ:MSFT) Xbox One -- the two top-selling eighth-generation gaming consoles -- both use AMD's semi-custom low-power APUs.

Therefore, Sony and Microsoft's upcoming AR/VR headsets will be directly powered by AMD's APUs if they're hooked up to consoles. In 2016, Sony will launch Project Morpheus, its VR headset for the PS4. Microsoft will also eventually launch HoloLens, an AR headset that overlays virtual objects onto real things, for Xbox One and Windows PCs.

Microsoft's HoloLens. Source: Microsoft.

Intel's HD Graphics and NVIDIA's Project Denver are also all-in-one APU chipsets, but neither one matches AMD's presence in console gaming.

A growing market
Sony and Microsoft aren't the only companies expanding into the AR/VR market. Facebook is expected to launch its VR headset, Oculus Rift, in 2016. Google got developers interested in VR apps with its DIY Cardboard headset, then partnered with Mattel to transform its classic View-Master into a VR viewing device. Google also invested over half a billion dollars into Magic Leap, the developer of an AR headset that could potentially compete against HoloLens.

Google and Mattel's new VR View-Master. Source: Mattel.

The arrival of those headsets will boost demand for beefier GPUs. However, some of them will need to be paired with mobile devices and PCs -- neither of which is AMD's forte. The mobile GPU market currently belongs to Qualcomm and Apple. Intel controls 72% of the overall GPU market, while NVIDIA controls 76% of the add-in graphics board market, according to research company JPR.

AMD's lack of GPU muscle in those markets could impact its ability to grow its AR/VR presence beyond gaming consoles. Moreover, there's no guarantee that Sony and Microsoft won't switch to NVIDIA or another chipmaker for APUs in future consoles.

Don't forget about the software
However, AMD has an alternative way to infiltrate the VR market: software. In March, AMD unveiled LiquidVR, a suite of technologies designed to reduce delays, or latency, in VR image processing, which can cause motion sickness. The suite only works with VR content running on AMD hardware. Several major AR/VR partners, including Facebook's Oculus VR, are already integrating LiquidVR into their devices.

Until now, reducing latency was mainly considered a hardware issue. Last year, NVIDIA claimed its GeForce GTX 980 could reduce the Oculus Rift's latency by up to 50% in comparison to older cards. However, the GTX 980 is a top-tier card that costs $500-$600. Add that to the expected $200-$400 price tag for the Rift, and customers might have to pay $1,000 for an optimal VR experience.

With LiquidVR, VR applications might eventually run smoothly on cheaper graphics cards. The suite is also an early step toward a unified API for VR gaming, which could attract a lot more developers and vendors as the market matures.

Not a magic bullet
The AR/VR market is an exciting market to watch, but it's not a magic bullet to solve AMD's core problems.

Last quarter, revenue at both AMD's Computing & Graphics unit and its Enterprise, Embedded, and Semi-Custom (EESC) unit fell annually. The former posted an operating loss of $75 million, while the latter -- which houses AMD's higher-growth console and microserver SoCs -- stayed in the black, with an operating profit of $45 million.

Rising sales of VR/AR devices might boost console sales, which could cast a halo effect on sales of PC-based add-in graphics boards. If the VR market matures and LiquidVR becomes an industry standard, AMD could possibly sell cheaper add-in graphics boards that can match the VR performance of pricier NVIDIA cards.

Unfortunately, none of that will likely happen within the coming year. Until then, AMD must find other ways to get its top- and bottom-line growth back on track.