Upon leaving Magic Leap and returning to his home country, Chi Xu harbored significant aspirations. He anticipated that China would cultivate its own leading companies in the augmented and virtual reality sectors, mirroring the success of its domestic smartphone industry which produced global competitors such as Huawei, Oppo, and Xiaomi – companies that now challenge Apple’s dominance.

Xu, currently the chief executive of Nreal, a highly-funded AR startup in China, is part of a cohort of entrepreneurs uniquely equipped to develop top-tier hardware. This younger generation possesses a dual understanding, having gained professional experience in Silicon Valley and frequently holding degrees from prestigious Ivy League institutions. They also benefit from strong connections to both financial resources and supply networks within China, enabling them to refine and deliver robust, yet reasonably priced, products.

While they take pride in China’s advancements in technology, they understand that achieving complete leadership requires time and effort. Crucially, these companies often maintain complex relationships with the United States, whether for acquiring essential components or evaluating initial market reception.

Despite the Chinese government’s emphasis on technological “self-sufficiency,” Chinese AR and VR businesses still rely on imported chips, much like their smartphone industry counterparts. Given the industry’s nascent stage and the absence of a demonstrably successful monetization strategy, limited investment in fundamental research is seen from both investors and startups within China.

However, China possesses a key advantage, according to the anonymous founder of a Chinese AR startup: “China has historically faced challenges in pioneering innovation, moving from ‘zero to one.’ Nevertheless, it excels in mass production and boasts the supply chain infrastructure needed to scale from ‘one to n.’”

This pattern was evident with smartphones. After Apple showcased the potential of mobile handsets and fostered a production ecosystem around the iPhone – effectively propelling the industry from zero to one – Chinese companies learned from the American innovator, leveraged their domestic manufacturing capabilities, and began offering more affordable and equally powerful alternatives.

“I don’t foresee any Chinese companies making AR and VR investments on the same scale as Microsoft, Apple, or Facebook in the current landscape,” stated the founder, whose company distributes headsets both within China and internationally.

“Instead, China is adept at accelerating development by focusing investment on competitive endeavors with defined objectives. For instance, in the realm of chips, if competitors already exist, Chinese firms can achieve results by increasing investment and pursuing a similar path.”

Chinese innovation

Despite China’s decade-long push for greater self-reliance in technology, the most sophisticated technologies powering augmented and virtual reality remain largely controlled by international technology leaders, according to multiple industry analysts who spoke with TechCrunch. The Snapdragon processors from Qualcomm are almost universally utilized by key companies in the field, ranging from Oculus Quest in the United States to Pico and Nreal within China. Furthermore, cutting-edge optical components are primarily sourced from companies based in Japan and Taiwan.

This does not indicate a lack of innovation from Chinese firms. Well-known venture capitalist and artificial intelligence authority Kai-Fu Lee notably proposed in his publication “AI Superpowers” that while the United States excels in foundational research, China demonstrates greater strength in practical application and commercialization.

“It is accurate that the United States is where more exploratory development is taking place, although I am uncertain if any of these projects have reached full maturity,” stated Tony Zhao, founder and CEO of real-time video API provider Agora and a former executive at WebEx, in an interview with TechCrunch. “Chinese businesses, however, are discovering more possibilities within the realm of [user experience].”

As AR and VR technologies mature, Zhao’s organization is developing a toolkit designed to enable developers and institutions to broadcast and record AR content directly from devices. The applications developed by Chinese educational institutions have particularly impressed Zhao. For instance, one client created a platform that allows a teacher to engage with a student within a simulated retail environment, where they practice English conversation while role-playing as a cashier and customer.

“I believe this approach is genuinely transformative, as many students will be highly motivated to learn through these types of interactive tools. It provides a more authentic experience and fosters a more natural learning process for language acquisition, moving beyond simply memorizing grammatical rules,” Zhao explained.

“These are already inventive and, importantly, highly functional solutions.”

The Chinese market also presents factors that continue to attract investor interest. As Gavin Newton-Tanzer, president of Sunrise International, Asia producer of the “mixed reality” (XR) conference AWE, shared with TechCrunch:

“Many observers believe that Magic Leap’s substantial funding in the U.S. stifled investment in other smart glass ventures. Funding a competitor to Didi in China or Uber in the U.S. would face similar challenges… There was a widespread feeling that no other company could realistically contend for market share.”

He believes the situation differs significantly in Asia. “In China, this does not appear to be the case. There is a notable level of diversity.”

In fact, the Chinese industry remains without a dominant player, with startups such as Hong Kong-based Mad Gaze, Rokid (supported by IDG Capital), and Nreal (backed by the founder of Xiaomi) competing vigorously in the AR space. A similar competitive landscape exists in VR, with companies like DPVR (founded by a former Intel engineer), Pico Interactive (led by a founder from major VR OEM Goertek), as well as established technology companies like HTC Vive and Huawei all vying for position.

“I think this is very beneficial for the industry,” Newton-Tanzer added. “Above all, I believe Chinese companies are doing an excellent job in reducing the cost of [AR and VR products].”

Market appetite

Despite a continuing stream of new companies in the augmented and virtual reality sectors in China, the level of investment they are receiving has decreased from its peak during the height of industry enthusiasm. According to data from the research company CB Insights, the Chinese AR and VR market experienced 55 funding rounds totaling $264 million in 2017. To date this year, only 29 deals have been completed, representing $150 million in funding. Even before the economic downturn caused by the pandemic, China saw just 27 deals and $194 million invested in the industry during 2019.

This reduced interest in China mirrors a similar trend in the U.S., although American AR and VR startups are still securing a greater number of funding rounds and larger amounts of capital overall. Globally, investors are reassessing the potential of this developing technology following the unsuccessful launch of Google Glass and the disappointing sales performance of Magic Leap.

Although fewer AR and VR businesses are receiving funding in China, recent investment activity has largely focused on Series B rounds. This suggests that the companies still attracting investment have demonstrated sufficient progress to maintain investor confidence in this relatively new field, which currently ships only a few million units annually.

“The industry has yet to produce a clear success story, either in terms of financial returns or technological breakthroughs. Startups require continued funding to support ongoing research and development,” explained Seewan Toong, an AR/VR consultant. “Investors are now exercising greater caution. Many of the devices currently available are primarily intended for demonstrations by large corporations and government agencies, or are limited to specialized markets such as the Oculus Quest.”

Until Facebook introduced the more affordable Oculus Quest, most advanced VR headsets were priced beyond the reach of average consumers, a product Toong describes as “heavily subsidized and not profitable.”

“Furthermore, there isn’t a compelling application for the business sector, as VR devices continue to prioritize entertainment, exemplified by the Oculus,” he stated.

AR also faces its own set of obstacles. While the introduction of mobile AR applications like Pokemon Go and AR-enhanced shopping attracted initial users, AR technology still needs to overcome numerous technical hurdles, including advancements in optical solutions, object tracking, virtual image overlay, and cost reduction, according to Toong.

Recently, the rollout of 5G technology has sparked renewed investor enthusiasm for AR and VR on a global scale. This next-generation network technology improves mobile broadband, which in turn lowers latency and increases data throughput, creating more immersive user experiences. Data processing can also occur at the network edge, eliminating the need for expensive, high-performance processors and thereby reducing the cost of smart or AR glasses, Toong noted.

Consequently, network operators are actively seeking collaborations with AR and VR device manufacturers who could potentially accelerate the adoption of 5G. Qualcomm, promoting a processor that enables seamless connectivity between headsets and 5G phones, has launched an initiative connecting 15 leading operators worldwide with device makers, including several Chinese companies such as Oppo, iQiyi, Nreal, Shadow Creator and Pico.

Driven partly by demand from the education sector and the availability of more consumer-focused products, China’s AR shipments have surpassed those of the U.S. this year, as reported by IDC analyst Yexi Liao to TechCrunch.

However, the U.S. continues to be the largest VR market globally. With the ongoing pandemic continuing to limit social activities in the U.S., many consumers are purchasing VR headsets for indoor entertainment and sports. In China, however, daily life and work have largely returned to normal since April, with only occasional localized outbreaks, making the appeal of virtual entertainment less significant.

Tech war

With Huawei continuing to experience the effects of U.S. sanctions, which have disrupted its access to essential chip supplies and impacted its smartphone operations, a key consideration is whether the U.S. will eventually limit the export of chips used in augmented reality (AR) and virtual reality (VR) technologies.

Newton-Tanzer expressed a lack of concern regarding this possibility, characterizing the AR/VR industry as comparatively “unproblematic.”

“This sector differs from others in that it doesn’t present the same level of sensitivity as areas like artificial intelligence or drone technology. XR technology is primarily focused on visual experiences and enhancing our interaction with digital environments. Both VR and AR are largely utilized for entertainment and educational purposes, making international discussions more straightforward.”

Liao of IDC also indicated that the U.S. is unlikely to impose significant restrictions on this market in the near future, as the industry is still in its early stages. “This contrasts with the smartphone market, where the U.S. is actively competing for leadership in 5G technology. The current market size of AR and VR is minimal when compared to the mobile phone industry.”

In contrast, international hardware companies may encounter difficulties in reducing their reliance on China, which remains a primary location for hardware manufacturing. According to industry consultant Toong, the majority of the world’s VR production currently takes place in China, while AR shipments remain limited.

IDC reports that VR headsets are projected to represent over 83% of global AR and VR shipments in 2020. This is partly attributable to the highly specialized nature of AR applications.

“Currently, there isn’t a universally compatible software platform or operating system for AR devices, necessitating extensive customization. As a result, we see government organizations purchasing large quantities of headsets – around 10,000 – for very specific applications,” explained Newton-Tanzer.

This relatively small scale also simplifies the potential relocation of AR production outside of China, should companies decide to do so.

“The amount of production that would need to be moved is not substantial. The technologies behind AR glasses, including lens technology and SLAM, are new and produced on a limited scale, meaning many countries could serve as viable manufacturing locations. However, China’s established manufacturing capabilities will likely provide a lasting advantage in building a large-scale supply chain, and I anticipate China will continue to play a significant role in production.”

Beyond China

Increasingly, we are witnessing Chinese hardware companies expanding operations outside of China. For example, Mad Gaze currently holds a position as one of the five leading AR headset brands sold in the United States, based on information released by IDC. In the virtual reality market, both DPVR and Pico are recognized as top ten companies within the U.S.

These businesses present products frequently comparable to those developed in Silicon Valley, while simultaneously benefiting from more competitive pricing due to China’s established supply networks and cost-effective workforce. As Xu of Nreal explained to TechCrunch, they leverage their technical expertise gained internationally alongside the substantial manufacturing capabilities available within China.

However, expanding internationally is presenting new challenges. A number of Chinese companies are grappling with how to present their brand, and some are minimizing their connection to China in an effort to sidestep the increased oversight faced by companies like Huawei and TikTok in international markets. Those prioritizing international growth are actively focusing on localization strategies, including hiring personnel within their target countries and navigating regulatory requirements. The strategies employed by emerging Chinese AR and VR companies as they expand globally will be noteworthy.