Are We Expecting Too Much From Facebook Inc's Oculus?

Gamescom 2014. Image source: Marco Verch via Wikimedia Commons.

It's been more than 20 years in the making, but virtual-reality technology finally seems set to arrive. And there's probably no single project that's more heavily anticipated than Facebook's (META 3.17%) Oculus headset, set to hit store shelves early next year and aimed at gamers.

Virtual-reality technology is exciting, and Facebook's deep pockets should drive it forward at a much faster pace than it would have if Oculus was still independent. Facebook paid $2 billion to acquire the VR headset maker in 2014. But are investors getting ahead of themselves by assuming a fast-growing market for Facebook's VR technology?

There are a few key points to consider when looking at the potential for Oculus. First, there's the overall market for virtual and augmented reality, which seems set to explode. The firm Digi-Capital expects the market to grow from just a few billion dollars next year to $150 billion by 2020.

That's a truly staggering figure. It rivals the annual revenues of some of the world's largest tech companies today. Facebook's annual revenue last year was just less than $12.5 billion.

But that optimistic forecast is based on the adoption of a wide array of technologies and applications for those technologies. Virtual reality machines like the Oculus Rift, which truly immerse users in a virtual world, would represent only a small piece of that overall pie.

Virtual or augmented?
Digi-Capital sees VR's reach limited mostly to games and 3D films, with "tens of millions of users," if hardware prices are similar to gaming consoles. Where the lion's share of opportunity resides is in augmented reality -- the technology that allows users to place digital images into the real world.

Digi-Capital sees many more applications for AR, and believes its addressable market is similar to the smartphone. It projects the AR market to grow to $120 billion of that $150 billion in 2020. Other forecasts have been much more conservative. Looking at just devices, CCS Insight estimates sales in the area of $4 billion by 2018.

MarketsandMarkets forecasts the overall VR market to grow to just less than $16 billion by 2020. That's just a sliver of the $270 billion-plus smartphone market. But it's still an impressive figure that would represent an annual growth rate in the area of 63%.

More than games
Virtual and augmented reality have applications that stretch far beyond gaming. The technology could be used in everything from car buying to tourism and from exercise to psychological therapy. Facebook CEO Mark Zuckerberg noted recently that, while gaming will likely drive the early sales of its VR technology, over the long term, the bigger potential is in day-to-day communications.

"Once we start to get more of a critical mass, I think you can start to get social applications, which is what we, as a company, are more interested in over the long term and think have a huge amount of potential in addition to the video and gaming stuff, which I just think is going to be awesome in the next few years, as well," he said during a conference call with analysts. So Facebook sees that potential and will look to tap into it.

A crowded field?
Facebook, however, is far from the only player in virtual and augmented reality. KZero is tracking no fewer than 20 different VR and AR projects that are underway. While Zuckerberg believes that Oculus will indeed be the best VR experience consumers can get, the broader market for VR and AR technology could well remain fragmented for many years to come.

In some key ways, virtual and augmented reality bear a resemblance to 3D printing. It's technology that lends itself to an infinite number of applications and is expected to see explosive growth in the coming years. And there are a wide variety of players looking for a piece of the market. These include everything from small upstarts to tech and industrial giants.

Let the game play out
With great anticipation, investors -- this one included -- gobbled up shares of 3D companies as they climbed to new heights. But a couple of years later, no clear winners seemed to be emerging in 3D printing, at least in terms of the machine producers. And investors who bought shares of the public 3D companies are likely in a world of pain today when they look at their returns.

Virtual reality may, in time, prove to be a lucrative business for Facebook as the technology finds more everyday applications. But its true potential may be further off in the distance.

We should be excited about virtual reality and augmented reality. It's fascinating technology with a bounty of interesting, useful applications in business and life. But as investors, we would be wise to remain cautious, watching how the market will develop, and seeing which players' technology is adopted on a broad scale.