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How Facebook plans to dominate virtual reality in real life

·Technology Reporter

Last summer, Facebook (FB) CEO Mark Zuckerberg took Samsung (005930.KS) vice chairman Jay Lee on one of his famous walk and talks. The subject for Zuckerberg and Samsung's heir-apparent was the two companies' partnership in virtual reality.

Samsung was contributing its hardware expertise, specifically with high-resolution screens, while Facebook supplied software and applications from Oculus VR, the pioneering virtual reality upstart that Zuckerberg bought for $2 billion in 2014. As the two talked, Oculus had already introduced its own VR headsets, which would later go on sale for $600, and an earlier offering from Samsung that used a smartphone as a screen was being sold for $200.

But Zuckerberg wanted to drop the price even more to attract the tens of millions of customers he needed to reach a mass market audience and eventually get to the scale of Facebook's 1.6 billion users.

"We talked about how we could bring this experience to the most people possible," Zuckerberg recalled last month during his surprise appearance at a Samsung event in Barcelona. "And after that we decided to target a $99 price."

Now Samsung is about to deliver millions of its updated Gear VR headsets for even less than that. Lee and his team decided to give away a free headset to everyone who pre-orders the new Galaxy S7 and S7 Edge smartphones, arriving in stores next week (otherwise people will pay $99 for the headset). That will immediately create a huge audience for Facebook's Oculus platform, with its hundreds of games, interactive videos and other apps. And even higher on Zuckerberg's priority list, it will also massively expand the potential viewership for thousands of virtual-reality-like videos already uploaded to Facebook's social network.

Although there are only some 20,000 such videos posted on the giant social network among the many millions of ordinary videos, the number should grow quickly, again thanks to Samsung. After showing off new phones and its updated VR headset in Barcelona, Samsung also introduced the Gear 360 camera, a tiny, spherical device that anyone can use to shoot VR-like footage. It's slated to go on sale for $400 in the second quarter. Reporters and other attendees at the event were blind to Zuckerberg's surprise entrance because they were watching a demonstration of footage shot on the 360 camera, leading to one of the most iconic photos ever taken emphasizing how quickly technology is changing in an increasingly digital world.

Oculus's own VR rig has built in high-resolution screens and doesn't need to be connected to a smartphone. But it does need to be connected to a relatively powerful PC costing $1,000 or more to do image processing. Oculus started taking pre-orders in January with a March 28 delivery date.

Scaling the VR market

So what does Facebook gain by partnering with Samsung if its Oculus unit is already producing competing, if much more expensive, VR hardware? Facebook needs Samsung "to help it build scale around its VR efforts, which will be critical to attracting content and helping people become familiar with the concept," says Jan Dawson, chief analyst at Jackdaw Research. "The hardcore gaming rigs Oculus makes will only ever be a subset of that overall VR market, but Samsung is a key partner in helping Facebook to tap into the larger opportunity."

Facebook and Samsung are just a few of the players aiming to tap that opportunity, of course. Sony (SNE) and HTC have introduced similar gear and Alphabet's (GOOGL) Google is working on software for its Android ecosystem. Apple (AAPL) hasn't said much but has made several acquisitions in the field and is widely rumored to be prepping its own VR offering.

The entire market for virtual reality hardware and software is expected to grow exponentially over the next few years. Almost all of a projected $6.7 billion this year will be spent on hardware, according to a report by market research firm TrendForce. But as the market grows tenfold to $70 billion in 2020, a majority of revenue will come from software.

And that's where Zuckerberg has a big advantage. Mass-market VR content, whether from Hollywood studios or top videogame producers, will be available for all platforms and won't provide much differentiation. But the social side of VR, the home-made VR videos and viral, wacky content and eventually shared VR social experiences, could be far more significant. Apple has repeatedly struck out trying to create social networks and while Google has YouTube as a strong platform to build from, its more social efforts such as Google+ have also foundered.

Zuckerberg is counting on VR ultimately becoming a social experience, the realm where Facebook dominates. In recent talks, he has sketched out a future five or 10 years down the line when VR gear will be so sophisticated and realistic that people will be able to "gather" with their friends around a virtual camp fire or movie theater to hang out with each other despite not being in the same physical location. It's a vision right out of the science fiction writings of authors like William Gibson or Neal Stephenson.

"People will always want more immersive ways to express themselves," the Facebook founder said in a recent interview with German newspaper Die Welt laying out his vision. "If you go back 10 years ago on the Internet, most of what people shared and consumed was text. Now a lot of it is photos. I think, going forward, a lot of it is going to be videos, getting richer and richer. But that is not the end. In the future, I think you are going to want to capture a whole scene, a room, to be able to transport to that. To be able to stream what you are doing live and have people be able to interact in that space."

Echoes of the PC boom

In some ways, Facebook's partnership strategy echoes the moves Microsoft (MSFT) made in the first few decades of the PC revolution. First, Bill Gates partnered with IBM (IBM) to help make the DOS command line-based operating system dominant. As PCs got more capable, DOS evolved into Windows and then Windows became a platform for the Office productivity software. And as most companies started using Windows and Office, Microsoft moved into software for servers and networking.

It wasn't until Gates had retired and smartphones had overtaken PCs that Microsoft's hold slipped. In each prior transition, Microsoft kept tight control of the software, which could not be easily copied, while hardware became increasingly commoditized. And Gates managed to leverage the big audience he built at each stage into a dominant position for the next stage.

So now, in the earliest days of virtual reality, Zuckerberg is partnering with one of the two leading high-end smartphone makers, Samsung, to build the largest possible audience for launching his VR software platform.

And Zuckerberg's bet is that software will win out again. "There is a time early on in the development of any new platform where you really need to do the hardware and the software at the same time -- only later does specialization become valuable," he said in the Die Welt interview. "Our long-term role will be in the field of software."

It will take a long time to see if the Facebook founder's VR bet carries the day, but it looks like he's jumped out to the early lead.