Exploring the AR/VR Revolution: Opportunities, Challenges, and Venture Capital Perspectives

reams of a digitally-enhanced environment have long been a fixation in modern society. Those dreams were further advanced by the futuristic vision of a holodeck in Star Trek: The Next Generation. The future is now.

As computational power, software engineering, and display capabilities have increased exponentially, we are getting closer and closer to the realization of this dream. Augmented and virtual reality are becoming viable. It is only a matter of time. In their incessant quest for the next big thing, venture capitalists have taken note and the money is pouring in. 2021 was the second-best year ever for VR/AR investment with almost $4 billion flowing into startups in the space—a figure that was just behind the $4.4 billion invested in 2018:

An important question to consider is why is there such a gold rush to invest in AR/VR? What are the factors driving investor interest in this technology sector?

AUGMENTED REALITY VS VIRTUAL REALITY

What is augmented and virtual reality? And, how are they both different and distinct? Augmented reality is essentially a hybrid digital experience. It is a partially-immersive 3D interactive experience that incorporates both the real world and digital content. As such it requires far less computational power and novel hardware and is therefore much more accessible. 

There are many advantages to augmented reality, particularly with regards to answering “what if” questions. What if I would like to see how an existing home would look with the addition of another room? Instead of guessing, a more accurate visualization can be made with the use of augmented reality technology. While augmented reality adds to or alters one’s perception of the real world, virtual reality completely replaces the real world with a fully immersive, simulated one rendered by computer-generated graphics. 

How the user interacts within that virtual world is a function of the rules of the system whereas in augmented reality, the user has control. Naturally, to be believable, this requires far more computational power and much more advanced hardware including headsets and full-body tracking sensors which is why virtual reality has gained less traction in the market. It is simply technically far more difficult to create a credible digital world than to add digital features to the real world.

There are also safety issues as ironically, a virtual world that is fully immersive is also one in which the user could become so lost that they could physically hurt themselves as they move about within it. To summarize, the differences between AR and VR are as follows:

• AR uses a real-world setting while VR is completely virtual
• AR users can control their presence in the real world; VR users are controlled by the system
• VR requires a headset device, but AR can be accessed with just a smartphone
• AR enhances both the virtual and real world while VR only enhances a fictional reality

According to Statistica, the global market for AR and VR is growing and will reach approximately $300 billion by 2024 with AR technology deriving about a quarter of its revenue from industrial and manufacturing industries seeking to leverage its utility with regards to design. Indeed, enterprise adoption of AR is projected to grow 66% CAGR through 2026. In contrast, VR is growing most consistently within the gaming industry whose users are always hungry for more immersive digital experiences. Overall, user penetration in the AR/VR B2C market is expected to increase from 28.8% in 2023 to 32.6% in 2027.

USE CASES

Both augmented reality and virtual reality are a part of what McKinsey has termed “immersive reality” technologies: 

A great deal of the attraction of venture capitalists to AR/VR is that these technologies have a variety of use cases that can be harnessed and capitalized across multiple industries:

Education

Both AR and VR can facilitate learning and skills assessment. They are especially useful for reducing training risk in unusual or dangerous cases that are difficult to safely simulate in real life. Examples include fighter-jet and other warfare training which are dangerous, stressful and expensive. Other educational use cases include remote collaboration or conferences/events wherein AR/VR make it possible to dramatically expand the reach of the teacher/speaker and increase the quality of communication. It is estimated that 226 million educators of the 2.7 billion deskless workers globally will be positively impacted by AR/VR.

Product Design and Development

AR/VR is also a useful product design and development tool. Indeed, it is estimated that 100% of the design of physical products and spaces can be simulated in a digital environment; and 265 million construction/real estate and 427 million manufacturing workers globally can benefit from these technologies.

Gaming

Gaming or more broadly media and entertainment is an interesting market segment for AR and VR, particularly the latter. On the one hand, gamers are attracted to the possibilities for total immersion offered by VR but on the other hand, these users have the highest expectations for their user experience. This means that they are a driving force behind advancements in VR and AR technology as they place the greatest demands on the technologies. They are also the early adopters who are most likely to purchase new innovations. However, gaining broad market share within the media and entertainment segment will be difficult since they are so hard to please. 

Retail

Retail is a huge segment of the economy that has been revolutionized by e-commerce. The next phase of the digital commerce revolution is the deployment of AR/VR technologies. There are still bottlenecks in the industry like the challenge of finding an item in a store or figuring out if it will fit you. AR/VR will alleviate those challenges with 3D catalogs that provide greater precision in assessing the dimensions of an item and how it will look in your home as well as where it is in the store or if it is in stock; and interactive try-on visualization tools that allows one to see what the item looks like when you where it or how you appear in different colors and variations of the item. 

CHALLENGES

Despite all of these market opportunities, there are also challenges in the AR/VR industry that are inhibiting monetization. The pace of hardware improvements while growing has still not been sufficient to provide a seamless, well-integrated experience particularly in the VR space. 

Specifically, greater miniaturization, weight reduction, wireless capabilities and more advanced, precise sensors as well as nausea mitigation are required to improve the VR experience. Relatedly, these technological improvements must be made available in the market at a sufficient cost reduction to induce consumers to adopt the new technology. This requires great financial and technical investment on the part of venture capitalists and technologists but the rewards are immense. 

Another complication has to do with the absence of a single platform like Android or Windows that innovators can confidently build off of knowing that there is some certainty of adoption by the users of that platform. Security and privacy are also concerns. Experiences as completely immersive as VR and to a lesser extent AR are also deeply personal as they gather and leverage intimate information and deploy them across multiple technologies—body sensors, smartphones, virtual environments—that must all work together but also be secure as they do so.

VENTURE CAPITALIST PERSPECTIVES

Due to these benefits, challenges and market opportunities, while the market is nascent it is not too early to invest with AR being the safer short-term opportunity and VR being the bigger but riskier long-term opportunity. According to VC investor Brayton Williams: “We believe VR is still the largest long-term opportunity of the two. AR complements the real world; VR creates endless new worlds.” Moreover, according to Niko Bonatsos of General Catalyst, mobile and sports may be the best beachhead market for AR/VR: 

Companies to watch are the ones that are creating cool experiences with mobile as the first entry point. Wave VR, Rec Room, VRChat are making it really easy for consumers to get a taste of VR with devices they already own. They’re not treating VR as just another gaming peripheral but as a way to create very cool, often celebrity-driven, content. These are the kinds of innovations that makes me optimistic about the VR category in general.

In both AR/VR, a founder needs to be both super ambitious but patient. They’ll need to be flexible in thinking and open to pivoting a few times along the way. Product-market fit is always important but I want to see that they have a plan for customer retention. Fun to try is great, habit-forming is much better. Gaming continues to do pretty well as a category for VC dollars but it’d be interesting to see more founders look at making IRL sports experiences more immersive or figuring out how to enhance remote meeting experiences with VR to fix Zoom fatigue.

However, there seems to be investor caution regarding the hardware space. As noted earlier, there are many technical improvements that need to be made and hardware is quite capital intensive by nature. The hardware segment seems to be more in the domain of large technology companies like Microsoft, Sony and Google and their corporate venture capital arms who have the funds to channel into hardware as well as strategic partnerships to offer. Magic Leap which has received hundreds of millions in investment capital without much success is a cautionary tale.

AR/VR INVESTORS

Who are the top AR/VR investors? Given the immense amounts of capital required in the space, it is not surprising that corporate venture capitalists have gotten actively involved. Two of the most prominent are Bloomberg Beta and Intel Capital. Bloomberg Beta, which is the venture capital arm of Bloomberg, regards its mission as being to invest in powerful ideas that bring transparency to markets and achieve global scale with strong, open cultures that embrace technology.

Relatedly, it is interested in investing to make work more productive, fulfilling and available to as many people as possible. The entertainment and remote work as well as social media applications of AR/VR would certainly make that possible. Intel Capital is also investing in AR/VR as it stands to benefit through the increase in demand for its semiconductor chips as the industry develops. 

It is willing to be bold in its investments by making investments on the hardware side at the pre-seed, seed, and Series A levels. Investments include 3D Glass Solutions, which manufactures high performance, 3D RF passives and photonic devices; and Untether AI, a manufacturer of AI-enabled chips which will be a key component of the ongoing AR/VR revolution. 

There is also an emerging breed of venture capitalists who invest exclusively in the AR/VR space. This includes Dune Ventures, an early-stage VC firm focused on gaming, esports, interactive content and interactive technology. They have made pre-seed, seed, and series A investments in these areas. Among their investments are Ramen VR, a game development studio that is focused on building multiplayer cross-platform VR games like Zenith: The Lost City; Medal, a VR war game; and IndiGG, a 500 million member, NFT based Web 3.0 game in India. 

Another novel venture capital firm in the AR/VR space is HCVC (Hardware Club Venture Capital) which is the first community-based venture capital firm for hardtech startups. Founded in 2015 and headquartered in Paris but with global offices, HCVC originated to help hardware startup founders overcome shared bottlenecks and challenges by sharing contacts and knowledge. The club periodically selects hardware startups to support financially as well as to assist with business challenges like manufacturing, distribution, and supply chain. There are currently over 550 startups in 60 countries in the community. 

At the other end of the spectrum are large, traditional venture capital investors like BoostVC and Lux Capital. Both of these firms pride themselves on taking bold risks in leading/”bleeding” edge technologies so AR/VR are exactly what they are interested in. Boost VC wants to make “Sci-Fi a Reality.” It has invested in FitXR, a VR workout app; Sidequest, an early access layer for virtual reality; and Alta, a virtual reality studio. In addition, it administers a three-month accelerator program for entrepreneurs. 

Lux Capital seeks to “invest at the outermost edge of what’s possible and help companies that operate at the intersection of the new and not-yet-imagined.” Lux is huge with billions to invest across 8 different funds. Lux has invested in tools like Runway, an image and video creation tool that makes it easier to develop content in AR/VR spaces; and Clarafi, a communications platform for scientists, graphic professionals, students and educators interested in scientific visualization. Finally, the Venture Reality Fund seeks to do exactly what its name says—drive innovation at the nexus point of immersive, spatial, and intelligent computing through early stage and Series B investment. Investments include Phiar Technologies, a startup that is building the first AI-powered AR navigation driving solution that can run on a smartphone and in-vehicle displays.

Augmented reality and virtual reality are at what many regard as the best stage in their development for venture capital investors. It is evident how they can be used in a wide variety of use cases but no single actor dominates the market. This means that the market is large and dynamic but not hostage to a single or a few actors. Clear beachhead markets exist. 

There is also room for ample technological advancement which means that startups with strong technical expertise can innovate and capture the rewards to the benefit of both themselves and their investors. Investment has its risk, particularly on the hardware side. Still, it is often said but is nonetheless true that with great risk comes great opportunity.