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AR will be startup dominated, VR will not

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[I really meant to write this in a longer post because it’s arguable and I like to argue. But while this is timely because of the excitement around Pokemon Go, I’m working on something else and only had a few minutes to put it down.

Not sure why I’m apologizing for not giving you another 25-page, massively footnoted post…]

I don’t believe virtual reality is a good area to venture invest. I do believe augmented reality is a good place to venture invest. There is a key distinction between the two in terms of the chokepoints in the value chain.

Every media needs several components to work: the medium itself, the content, content distribution, monetization, and content discovery. Each of these pieces has its own economics, depending on the medium. The different economics leads to a different propensity to be controlled by a small group of companies.

Note that by medium I mean here the means by which content is presented to the user. So the medium for a newspaper is the printing press and paper. The medium for the internet is the network, etc. By distribution I mean the means of getting the medium to the user, not the act of doing so. So record labels may have a distribution function, but iTunes and Amazon are the means of distribution.

The radio industry had radio sets as medium, radio shows as content, distribution through radio broadcasts, and branded networks to facilitate content discovery and sell advertising. The cost of broadcasting and the economies of scale of content discovery and ad sales meant that the radio industry quickly became dominated by the networks, who owned these things, and the content creators were usually poorly compensated. The radio sets themselves were subsidized to build the audience needed to create the economies of scale for the networks and radio manufacturing was a break-even business.

This model, similar to what later happened in television, would have been a bad place to venture invest. The networks were built by companies that already had complementary assets and, more importantly, the cash and political power to establish dominance. The winners did not need venture-type financing (as it existed then) and companies that did need outside financing were inevitably destined to go out of business.

The movie industry developed differently. In its golden age it was dominated by the movie studios, who were primarily content creators. (The movie theaters were the means of distribution, not the studios.) This is similar to the record industry through most of its history. But because of the disaggregated nature of distribution and monetization, movies and music could be made outside of the studio/label system and occasionally make money (the “indys.”) Whether these were a good bet for outside financing is arguable, but the odds may have been no worse than VC if you knew what you were doing.

The internet is, again, different. Because there wasn’t a single chokepoint in the value chain, opportunities flourished in all sectors. Startups made (and make) money in the medium itself (meaning, here, companies like Cisco and AOL), content distribution, monetization, and discovery. There was some dominance in distribution, discovery and monetization over content creation, and this lead to early concentration at discovery companies like Google and monetization companies like DoubleClick. It has also lead to a very difficult environment for content creators1

In analyzing any new medium, it pays to figure out the various pieces of the delivery value chain and which ones will have the ability to take whatever share they desire of the overall margin available. These will be the one that become the valuable players in that market.

Virtual reality’s value chain is going to be dominated by content creation. Somewhat like the movies and more like computer gaming. The cost of creating VR content will be high so content creation will economically dominate distribution and discovery. The high cost of creating quality content will mean that less quality content is created, allowing discovery through typical marketing/PR and word of mouth (like how movies are discovered now.) Because recouping the cost of high-quality content will require large audiences, VR headsets will need to be cheap. They may at first be subsidized, but will eventually be required by the content makers to be high-volume, low-margin hardware. Expensive, and thus scarce, content will tend towards the lowest common denominator (like console computer games) so risk can be managed through a portfolio approach (like music and movies.) This suggests that VR content will eventually be dominated by a few very large companies, and probably mainly companies that enter from adjacent industries (my bet would be on EA.)

There may be other uses for VR other than the mass media/broadcast model I describe, such as in business. But because the largest piece of the market will drive revenue in the rest of the value chain down, any other value chain that avoids the chockpoint but uses the other pieces will have very low barriers to entry because its suppliers will have no bargaining power. For instance, the creation of training films for businesses avoided the content creation chokepoint in the consumer media business and benefited from the lower cost of movie-making equipment and talent. But because these had been made plentiful by the mainstream industry, there was no way to build a big business in corporate film-making. Something similar will happen in VR.

Augmented reality is completely different. Because uses of AR will be more varied, content creation will be less expensive (because there will be no “arms race” to create the single work that everyone sees.) No single part of the value chain will dominate. I expect AR to be more similar to the internet in its evolution. Content may explode in popularity overnight and then fade, but there will be no winner-take-all in AR content. Because content will need to be less expensive to make, content tool companies will be needed. Because this will lead to more varied types of content, hardware makers will do well: the hardware will be tuned to specific customer needs and content will address more specific customer problems, so AR will be more valuable to a customer than VR. This will allow both hardware makers and content makers to have higher margins. Distribution and monetization may end up consolidating, but not necessarily through existing players.

If my reasoning is correct, VC investments in VR will end up doing poorly as startups are outcompeted by incumbents. The AR market, on the other hand, is wide open.


  1. There’s an arguable point here about distinguishing between content creation and content discovery on the internet, and normally I would write several pages defending my choice but, luckily for you, no time. 

6 Comments

  1. Hi Jerry.

    No argument here (yet), but I would love for you to clarify your thinking in a few places (if you have a minute).

    Seems like much of your argument hinges on this statement:

    “Because AR use cases will be much more varied, content creation will be less expensive (avoiding an arms race)”

    Why do you have such conviction that there won’t be varied VR uses cases? It sounds like you think entertainment/media/games will dominate but that to me seems like the same conclusion a lot of people would have made about the internet in 1995. Why not social? Why not business apps? A static medium like film (corporate films) film seems like a poor comparison to The dynamism possible w VR (what does excel or CAD look like in 3D)? I guess I argued that films ability to create verticals outside entertainment is less a function of your value chain analysis and more a function of the mediums intrinsic qualities.

    Secondly, Can you give more definition to what form you see ar taking? Right now it sounds like you are projecting a fragmented landscape with bespoke hardware/software built around specific applications (like wearables) vs. a standardized hardware + specialized software set up (like mobile)?

    While I agree with the generic “commoditize your compliments” strategic analysis, I’d argue that the standardization of distribution on the internet was one of the biggest benefits to (smaller) content creators. The App Store and YouTube enabled lots of creators to reach much larger audiences than they ever would have been able to on tv. (Discovery was the choke point).

    Anyways, in a cab so sorry for not being more specific.

    1. It’s a good question and I wish I had time to clarify and expand the arguments. I don’t usually whip off posts in 20 minutes, but that is all I’ve got right now. I’ll approach it from a different direction:

      Because the uniqueness of VR is its immersiveness, the quality of immersion will be a key driver in what users perceive of as the quality of the experience. Competing on this dimension will become (as it did with PC gaming) a race towards realism, and we know that’s expensive.

      The uniqueness of AR is its interactivity with the environment. Competing on this dimension is more of a UI and customer-understanding problem and creativity and deep knowledge will be rewarded. Because creativity and insight can’t be bought, large companies won’t have an overwhelming resource advantage over startups.

      Re the form AR takes: if there’s a high-value, lower-volume application then it would make sense to build ad-hoc hardware and since I believe AR will have more of these, I think there will be more ad-hoc AR hardware. Hardware will probably be based on standardized components and eventually become commoditized (like PCs), but there is a long-ish window to build hardware companies. (The reasoning around high-value, low-volume might apply to VR also, but probably primarily in defense applications, where very low volumes can be sustained because budgets are so large. On the other hand, the ability for a newcomer to enter the defense market has nothing to do with quality of product and everything to do with politics, so not a good place for startups…unless your CEO is the person who can get something through the DoD purchasing process.)

      Re the App Store and commoditizing your complements: I would never invest in a company that makes its money from monetizing an app, would you? Some have done well, of course, but the expected value over the universe of app makers is clearly negative. (I haven’t paid attention to internet video, so can’t comment there.)

      1. Thx for the response.

        I’ve learned the danger of building on other people’s platforms (my first company was @sonar, a glorified mashup in retrospect) but saying that “you can’t make money on apps” is a bit like saying “you can’t make $$$ picking stocks (or startups).” Yes, I agree that I am going to “build a app” isn’t a business plan (unless you replace “app” with “website” and teleport to 1999) but Uber, Spotify, and Whatsapp are logistics, music, and communications companies, not “apps”.

        Platform shifts create a new markets and windows for insurgent companies to provide new new types of value in existing markets. The relevant point for our conversation is that when building on a platform (whether that’s iOS or Facebook), it’s important to know what the platform thinks its core value is. Building on a platform then trying to compete with it’s core value proposition is ALWAYS a bad idea (see every recruiting startup that tried to leverage Linkedin data). But I don’t see the strategic disadvantage of doing something unrelated (Uber didn’t threaten Apple so the advantages of building an iOS app far outweighed the benefits of building on a more neutral platform like the mobile web). Maybe that will change when apple rolls out it’s car…but I digress.

        All of this is a long winded way of getting at that I envision/hope for a greater diversity of VR applications than games (and bc of this, I think the VR platforms will be incentivized to create healthy, diverse developer ecosystems). I believe that immersion has advantages for tasks that require focus (creativity, productivity, education) and I think the richness of the experience will also lend itself to social (for the same reasons that stickers/emoji significantly enhanced messaging http://a16z.com/2016/06/17/stickers/ + My thoughts on social VR: https://medium.com/@brett1211/spending-time-with-dad-in-virtual-reality-628236458f48#.1zwd2unx2).

        Re: AR, one thing that your blog post and benedict evans’ ongoing commentary has made me realize is that AR means computer vision, image recognition/manipulation more than “hardware” and that Snapchat is actually the undisputed “AR” leader of the moment.

        Ciao!

  2. I would like to thank you for your recent article “AR will be startup-dominated, VR will not”.

    As CEO of a VR startup currently seeking VC investment a number of your observations really hit home. I believe as long as your original premise, “VR’s value chain will be dominated by content creation”, stays correct, you’re probably right. But what if that isn’t the case?

    What’s so interesting about the dichotomy of VR and AR is that right from the start, VR was a gaming platform and AR was an enterprise platform. At the same time you see Sony heralding their new generation of VR content, you see videos from the JPL, Case Western, and other leading research institutes showing how they plan on working in AR.

    This I believe is the real difference. Content for entertainment and platforms for enterprise are really the differentiating factor with this new generation of hardware. It’s just that off the shelf enterprise software seems much more appropriate in AR than it does in VR. After all, the working world is primarily concerned with non-virtual experience, for now.

    My company, Second Studio, is an enterprise VR platform targeted at the design fields, providing students and professionals alike a virtual space and tools to create and collaborate — borrowing many social mechanics from online gaming. Coming from a background in architecture and tracking the VR field since its inception, I couldn’t understand why we were spending so much time behind screens to design three-dimensional space – especially once the first VR development kits began appearing. Since so little design work ever transcends the virtual to become a physical thing, I chose to treat it as such and created a virtual platform to get designers off their screens and back in space.

    I challenge your original premise on the grounds that as a society we are becoming ever more digital, ever more virtual, and that all the new content we hope to use in these fancy new headsets will need to be created somewhere. That content will eventually need to be created in a virtual realm itself, using virtual tools. It’s not a question of VR vs. AR rather, a question of consumable vs. usable content.

    I would love to hear your response to this. As I stated previously we’re currently seeking VC investment ourselves and given the nature of our company, any advice you have for navigating the VR market would be highly regarded.

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