Waves of virtual reality and augmented reality startups have their funding. Venture capitalists invested $1.7 billion in the AR/VR sector in the 12 months ended March 2016, and $1.2 billion of that was invested in the first quarter of this year alone, according to Digi-Capital.

Is that crazy, given the low revenue figures expected for VR companies in 2016? Or is it appropriate, given that AR/VR could be a combined $120 billion business by 2020? Then there’s the VR market in China to consider, where investment levels are even more frothy.

We had a panel of experts take the temperature on VR at our GamesBeat 2016 event last week in Los Angeles. Sunny Dhillon, partner at Signia Venture Partners and a veteran game/VR investor, moderated the session. Joining the panel were Phil Sanderson, general partner at IDG Ventures; Alice Lloyd George, associate at RRE Ventures; and Marco DeMiroz, general partner and cofounder at The Venture Reality Fund.

Here’s an edited transcript of the conversation. You can also view the video of the panel embedded below.

Dealmaking conversations at GamesBeat 2016.

Above: Dealmaking conversations at GamesBeat 2016.

Image Credit: Michael O'Donnell/VentureBeat

Sunny Dhillon: How are you thinking about VR within games, first and foremost?

Phil Sanderson: Of the companies I’ve invested in, everyone’s thinking about adding a VR strategy. A lot of the companies I have, like Telltale Games, have licensed IP. They’re trying to get AR and VR rights, and they’re trying to start a relationship with HTC, Samsung, and the other companies to come out with product.

Of the companies I’m in, we’re not looking at it as a core revenue driver, but as something that adds value, similar to a software company having a European strategy or having patents. It adds value to the company in the long term. We’re not sure where the revenue is going to happen. My companies are not depending on that. These are not pure AR/VR companies. They’re just game developers and publishers.

Dhillon: Telltale has some triple-A licenses like Walking Dead, Game of Thrones, and Batman. When you’re seeing that IP come into VR, is it being seen more as a promotional transmedia strategy? Or have you seen any triple-A brands and IP come in with the hopes of seeing monetization in VR directly, say on a five-year horizon?

Sanderson: They talked about that on the panel before this, about how major Hollywood IP holders are focusing on AR and VR. I think they just don’t want to be caught off-guard. They want to be in a position to take advantage. I don’t see them getting in heavily yet.

When companies are starting to look at VR within gaming, it’s a combination of a PC experience with VR, or mobile with AR. It’s combining the two, as opposed to a pure play. I’ve been surprised by how quickly Hollywood IP is focusing on the category, but I don’t see them giving out full licenses, full carte blanche to do what they want with the IP unless it’s one of the big VR companies.

Marco DeMiroz: There’s another angle to that as well. One of our portfolio companies, Rogue Initiative, they announced a partnership with Michael Bay. There’s a lot of interest in Hollywood, as he said, to have a part of this medium. The dynamics right now — the installed base is still growing. Monetization expectations should be contained. The idea is to learn about the medium and then monetize as the installed base evolves.

Dhillon: When we’re talking about end-user expectations versus reality, I’ve heard various estimates. Google is talking about a monetizable audience happening in 2019 or 2020. That’s reflective of their expectations for Project Tango and mobile AR. Where do you, Marco, see an audience emerging, as far as both timing and sector? Are we talking about enterprise-level VR with guys like DAQRI? Are we talking about a gaming audience, with PlayStation 4 becoming more robust?

DeMiroz: First of all, I’m a huge optimist. I believe in the sector. My expectations for adoption and growth are probably more aggressive. We’re big believers in mobile VR. At the high end you have these console-like dynamics. Our portfolio construction had to do with the market timing and where the market was and where the trends were.

Three out of 10 companies are in gaming. Our expectations were that they could initially monetize at the high end. If you look at the app store, you see bundled product pricing from $2.50 down to $1.99. That’s a big spectrum for the first 200 games. Overall, the volume isn’t there. But our expectation is that on mobile VR — sometimes you’re a reflection of who you’ve been.

We’ve been coming from mobile gaming. If you look at mobile gaming as a meta-market trend, we had 100 million users in the U.S. in the summer of 2011. The economic model shifted from premium to freemium. In the second half of 2011 and forward the freemium economy was driving mobile gaming. Now it’s a $40 billion a year market. We expect similar uptake for mobile VR. Those numbers will probably happen in a 2018 time frame.

China is moving very aggressively. Stores are selling phone cases with built-in VR viewers from $5 to $8 apiece. There’s significant innovation happening in manufacturing coming from China for mobile VR. Our expectations for mobile VR will probably come to fruition in the second half of next year. In the meantime, we can make money in small amounts at the high end.

For other segments, if you look at our portfolio as a small sample of the sector, three companies in gaming, five in enterprise types of platform play, and two are core IP that you can monetize. Enterprise right now is monetizing very well. Our portfolio company, Spaces, announced a $30 million deal with Songcheng in China. That’s all theme-park stuff. Another company, Eonite, has a computer vision technology they’re monetizing. There are core technologies and platforms you can monetize. But on the consumer side, we’re at the mercy of installed base growth.

Alice Lloyd George of RRE Ventures at GamesBeat 2016.

Above: Alice Lloyd George of RRE Ventures at GamesBeat 2016.

Image Credit: Michael O'Donnell/VentureBeat

Dhillon: Alice, you and I are co-investors in a company called 8i, which is an amazing platform for volumetric content capture, rendering, processing. It’s a content creation tool based in L.A. and New Zealand. What are some of your thoughts around content creation tools right now as a safe bet for venture dollars?

Alice Lloyd George: There’s a lot of pieces in this, but following on what Marco was saying, I’m of the belief that mobile is not going to be as big in the near term as people think. The high end experiences are going to do better. That’s the nature of people reacting to novelty, when they try mobile VR for the first time, but it’s really the 10X you get from immersion that’s the sticky experience.

In the longer term I believe mobile will get there. You can do some back-of-the-envelope math with 60 million Samsung phones compatible with the Gear. Each year you do a five percent attach rate and you can get an estimate. We have the numbers from Cardboard. Five million units in the wild a couple of months ago, 25 million downloads from the Play store. We have loose numbers there. Not as many on the tethered high-end side, but we’ll get those numbers toward the end of the year.

Going back to your question on the content creation, everyone’s focused on these HMD units numbers, but really it’s about that virtuous cycle of content creation that will drive adoption. The more we can focus on content creation — are there any metrics there for how many developers are building? There’s a Greenlight report based on a recent survey. Fifty percent of developers have only started building VR in the last year. It’s picking up fast.

To your point, there is this roadblock with content creation tools. Right now you have to be well-versed in Unity and Unreal. We’re seeing a trend in more lightweight engines for creation coming along that may target a new kind of content creator, but it’s still very early, which is why companies like 8i are interesting. When we can get to the point of user-generated content — this is something 8i hopes to go for in the long run, how to capture people in a volumetric way, so it’s not flat 360 stereo stuff where you get fishbowl thing, but the immersive volumetric content. That’s when you’ll get the real pickup.

Guangzhou Zhuoyuan's 9DVR simulator is popular for out-of-home VR experiences in China

Above: Guangzhou Zhuoyuan’s 9DVR simulator is popular for out-of-home VR experiences in China.

Dhillon: If we look to China right now — China Joy has been going on the last few days. They’ve gone on this crazy tear of VR enthusiasm in terms of the $5-6 experience devices, or the giant mini-roller-coasters, the simulators that have VR looped in. Looking at China’s embrace of VR arcades, are you guys interested in that as an investment category? Marco, you’ve taken a step in that direction with Spaces. Is that something VCs should get involved with, given that it seems like a near-term monetizable audience?

DeMiroz: Our investment thesis for them was enterprise VR content publishing platforms, almost like a CMS for VR. They did that very effectively at Dreamworks Animation. They were coming from the background of a significant experience. What really surprised us was the interest coming from theme park operators. Songcheng and three others in China they manage, location-based entertainment across the country — obviously it’s a vast country, incredible population, and they’re very interested in the medium. They’re creating Void-like experiences across China over thousands of theme parks.

We weren’t necessarily betting on that. Traditionally, if you did mobile gaming, you could do something in arcade-based stuff, but maybe only 10-20 percent of your revenue. For Spaces and other companies, it could be a massive revenue-generating opportunity.

George: As a traditional software VC, it’s a trickier model in terms of economics compared to the stuff that we usually do and whether it scales, but it’s absolutely huge for VR. When you look at China and the price points people can reach, $2,000 for a PC to power your at-home device isn’t realistic. The retail experience is important for people getting to try it. HTC recently announced that they’re opening 10,000 locations for people to go and experience VR across China. It’ll be very important for getting adoption long term.

Audience question: Is there anything you would say, aside from content creation tools, that could be one of the bigger bottlenecks to getting to a sustainable marketplace?

Sanderson: I don’t know if you can depend on consumer revenue in the short term. The revenue’s coming from the big game companies. They’re starting to spend more money to get more content on their platforms. If you can get a contract with HTC or Samsung or Oculus, that can sustain the company.

Our biggest fear as VCs is, we back a company and the market takes two or three years to develop on the consumer side. Then they’re out of money and you’re going to recap the whole company. The investment goes to zero. It’s just too risky early on. The money is coming from the big game companies, so try to get the contracts through them. They’re starting to open up because they need more content.

PlayStation VR from Sony Interactive Entertainment

Above: PlayStation VR from Sony Interactive Entertainment.

Image Credit: Sony

George: A lot of people have talked about input and UI. That topic is well-covered. But one thing I don’t see people talking about is networking capacity. That’s not keeping up with Moore’s Law. There will be a lot of file-sharing loads and rendering issues on that side that we’re not prepared for. Even when you talk with the architects at AWS, they have these cloud front locations that are on the road map, but it’s really not a priority. Especially when you add in live and real-time VR, that’s going to be a big problem.

With AR you’ll have all this geospatial indexing capacity that we don’t have right now, and we’ll need it. The networking side of things, the core infrastructure, is still a bottleneck for wide-scale VR.

Audience question: What are your thoughts on peripherals and hardware? Are you investing in those areas in the near term?

Sanderson: If you’ve completely nailed the issue of haptics and gotten that down to something better than the three or four other companies I’ve seen out there toying with it — nobody’s really gotten that right. An L.A.-based company called Emerge, another company in the U.K. called Ultrahaptics, have been using microwaves as a means of making you feel a certain amount of static and force fields as you move from point A and point B. Others are doing it kinetically, with a moving controller. Tactical Haptics in Palo Alto is doing that.

Haptics is a very interesting area. Some folks are dabbling in it now, but it’s not seen a huge amount of strategic interest or investment that I’m aware of. But I think it will ultimately add to that level of immersion. If there are folks out there working on innovative ideas around haptics, I’d be interested in that.

DeMiroz: We don’t invest in hardware. A lot of times, the investment model has to do with the economics of that business and the size of the fund. For a $50 million fund, the capital needs of a hardware business are not a good fit for us. But in terms of user experience, it’s absolutely important. If you want to have an immersive experience in 360 video, perhaps with a game or storytelling in VR, you want to feel that you’re there.

If you have enough sensory input, your brain completes the loop. But you need to get sufficient feedback mechanisms to get that sense of being present in the environment. It’s absolutely essential to the ecosystem. But we’re just too small to invest in hardware.

One unfortunate thing about the peripheral business, the hardware business, is that it tends to get commoditized really fast. You have this incredible innovation and investment up front, and then the price points decline very rapidly. You get subsumed by one of the larger players. There’s a limited window of opportunity before the market dynamics flourish.

Dhillon: We’ve seen how much money guys like Jaunt and Next VR have raised in the 360 video space. We’ve seen big media companies like Disney get involved with their IP and strategic investment. We’ve seen a ton of interest from China and Hong Kong. When we think about 360 video versus the holographic light field, the more advanced stuff that’s still further away before there’s a large enough audience to enjoy it and return investment from direct consumer monetization, what are your thoughts on the billion-dollar valuations we’ll start seeing for some of these 360 video platforms doing sports and concerts and the like?

DeMiroz: Our investment thesis at Evolution Media Capital, when we invested in Jaunt, involved a number of factors. One was the incredibly sophisticated and deep team. The executive team came from a great tech background, plus David Anderman was COO of Lucasfilm. He sold Lucas to Disney. They knew a lot about media and entertainment.

The second part was the complete technology stack. They had the most advanced live action camera design, Jaunt One, which has 24 cameras. It has incredible HDR and everything else. They had the full software layer in the cloud to stream, stitch, process, preproduction, post, come back and publish on multiple platforms. We felt like they had solved the problem. They were ahead of everything else. Their model, as David said, was to become the Netflix of VR.

Over time, cameras will get commoditized. As a publisher you have to acquire critical mass to become a dominant force.

Sanderson: Short-form videos will be a really good near-term opportunity, sort of like episodic content. I can see that being a lot more popular than most games. One of the fundamental issues I see in the market — this is a bit contrarian — is that the headsets have a long way to go. They still make people dizzy. They heat up. They look very awkward on your head. They’re expensive. You’re still talking about the alternative of buying an Xbox and a Call of Duty game for $350. That’s an incredible experience. The VR experience is amazing, it’s novel, but it has issues.

That type of content may lead the market to get it seeded and get it going. Then we’ll see gaming come in afterward when people have more headsets and some of these issues are solved. I see some of the high-end experiences as similar to a Tesla S model: something for enthusiasts. It’s high-priced. But it’s proving a market. The electric car market took two or three years to follow that and become mass-market. That’s going to happen here.

I’m looking at everything as an investor, but I’m not making any investments yet. I will be, probably in the next 12 to 24 months. It’s hard to say. We all have our guesses. We know what the fundamental problems are. We know how good things are. I’m just saying that content-wise, I can see short-form video being a driver. That’s a good space. People can enjoy Netflix-style episodic content. That’ll be a driver.

Oculus VR had a big booth to tout virtual reality. There were 53 VR companies.

Above: Oculus VR had a big booth to tout virtual reality. There were 53 VR companies.

Image Credit: Dean Takahashi

Audience question: In terms of seasons of VR, it’s been frothy. We’ve seen a lot of investments happening. What are your opinions on whether we’re heading into a winter of VR, where this first wave will fall off?

Sanderson: You have to remember, it’s Google and Facebook’s job to spend one to two percent of their market cap on a new platform that could be the next platform. They have to spend their stock on that. It isn’t that big deal. That doesn’t prove a market, just because they spend a few billion dollars in it.

You have big companies like Samsung and HTC putting money in. They’re committed. It’s going to last. There will be some carnage, though, if there isn’t consumer revenue in the next few years. It’s hard to say whether there will be. But those companies are funding a lot of the content and tools companies. The ecosystem is going to grow.

We saw that study at the last GamesBeat, where 16 percent of all game developers are developing for VR. It’s happening. It’s going to take some time and it’s going to develop.

George: I agree that these big players putting their stakes in the ground is important. There are different curves that hit at different times. The tech curve, they’re helping to accelerate that. The distribution curve, we’re starting to see that. The content curve, which is the most important, is last. That’s the key question. Are we still in gestation or are we getting to growth?

I think we’re still in that awkward adolescent phase with that. It’ll be a few years until we get really good content, and then the pickup will come.

Dhillon: A lot of us are looking to this Christmas, with the PlayStation, and seeing how that takes with the price point it’s at and the peripherals you’re buying with it, like the camera and so on, and the launch titles that will be shipping with it. It’s technically a step below the PC-tethered room-scale experience of the HTC Vive. Some people could say it looks a little ridiculous with the wands in your hands. But with the direct-to-consumer marketing push that a giant like Sony understands, and having them understand triple-A game development as well, a lot of hopes rest on that working for the first mass-market exclusive VR device.

Sanderson: In terms of price points, they’re pretty high at the moment, as we know. But if you convert some of the older platforms to today’s dollars, the Atari 2600 in 1977 was $770. The NES in 1985 was $430. The Panasonic 3DO in 1993 was $1,100. The entry point is $1,500 now. That’s really expensive. It’ll come down, but right now it’s for enthusiasts. Because there are so many PlayStations out there, though, that could be what really takes off.

George: I agree on the PC investment side. It’s expensive. If you just look at the HMDs — $399 for Morpheus, $599 for the Rift, $799 for the Vive — when the iPhone came out it was also $599. That was before anyone thought they had to have this thing, in 2007, and people were still paying that price for it. If you think that this is not an incremental media change, but that it’s the next computing platform, you’ll pay $599 for it.

DeMiroz: We’ll have a bifurcated platform overall, I think. We’ll have the mobile dynamics. You can’t judge it based on current price points. These are early adopter points, and mostly in North America. Given the enormity of the undertaking by pretty much every tech, media, and entertainment company globally to be on VR and AR platforms, we should experience very rapid cost decline. The price curve will accommodate the mobile and console sides.

You can’t have a massive installed base globally at $2,000, but there are 45 million PS4s out there right now, with 3-4 million more units forecasted this year. Maybe triple that next year. You have this installed base that will continue to evolve. And the mobile side will build up these very easy-to-use, convenient form factors that you can purchase as if you’re purchasing a phone case and consume VR content.