When mobile game Pokémon GO launched in July 2016, it quickly became one of the most successful apps of all time, with more than 500 million downloads in the two months after its debut. The game gave users a taste of augmented reality, or AR, by letting them locate and capture Pokémon creatures that, when viewed through smartphone cameras, showed up in the physical world.
That same technology—which superimposes digital images on a user's view of the real world—has the potential to revolutionize e-commerce, entertainment and health care, to name a few applications, and all via smartphone.
“We see the camera becoming the main input and output function on smartphones, allowing users to create and experience rich images and video with the special effects of professional film," says Katy Huberty, Morgan Stanley Equity Analyst covering the Technology Hardware industry.
For smartphone makers, developers, technology platforms and components companies, meanwhile, AR promises to be the next killer app, extending the life of the smartphone market, accelerating upgrades and driving demand for new apps. All told, AR could add more than $400 billion in incremental sales for mobile devices and related services over the next three years.
In a recent Morgan Stanley Research report, Huberty and her colleagues offer a detailed look at this trend and its implications for investors.
Augmenting the Smartphone Market
The first generation of AR, which relies on standard rear-facing cameras, has already started to impact social media and e-commerce. It lets Snapchat users create funny 3D effects and helps Ikea customers virtually place and arrange furniture before they buy.
AR has the potential to spark the next big smartphone supercycle, and bring a whole new dimension to the mobile experience.
The next iteration of AR uses dual cameras and 3D sensors to create even more realistic experiences. Apple's newest iPhones, for example, have front-facing 3D sensors that project infrared light into the real world to improve depth perception and detect image patterns. Other leading smartphone makers are expected to roll out similar technology next year, potentially giving new oomph to the entire industry.
"In our bull case forecast, we assume that the global smartphone replacement cycle contracts by 1.8 months by 2019, similar to what we saw in 2014," says Huberty, noting that in 2014 there was a 152% year over year surge for smartphones which had display greater than or equal to 5”.
Under Morgan Stanley's most bullish scenario, AR could push smartphone shipment revenue's compound annual growth rate to 18% for 2017 through 2020, up from the current estimate of 11%. That represents $286 billion in incremental revenue for device makers over that period.
Nurturing the AR Ecosystem
Of course, broad adoption of AR isn't just about the hardware. Consumer and business demand for AR hinges largely on the applications the devices support. Although it will likely take years for AR applications to mature, says Huberty, Apple's June 2017 launch of its ARkit for developers, followed by Google's ARCore in August, are notable.
“We liken the impact of AR to the launch of the Apple App Store in 2008," she says. “It was the app store that allowed users to consume and create information in a way that was optimized for mobile, expanding the range of computing functions and therefore demand in the market."
App developers and service companies stand to see their own incremental revenue gains, to the tune of $118 billion over the next three years, for Morgan Stanley's bull-case forecast. “Under this scenario, we see services growing at a compound annual growth rate of 23%, up from our current forecast of 19%," Huberty says, noting that large platforms will be among the biggest beneficiaries as AR becomes more mainstream.
Meanwhile, AR is an opportunity for component makers to sell smartphone users add-ons that support or enhance AR. Morgan Stanley estimates that 25% of global handsets today cannot run mobile AR, and each of these handsets would require a $10-per-device upgrade.
Under Morgan Stanley's bull case, users of about 600 million low-end smartphones would pay $12 each for a rear-facing 3D sensing module, plus $30 to improve processing. Users of mid-level and high-end phones may also pay a premium for components that further improve AR. In total, AR upgrades could add up to $38 billion in incremental revenue.
This outlook is predicated on device makers rolling out quality 3D technology over the next year; developers moving quickly to create AR-based apps, and consumers incorporating AR into their everyday mobile lives. Still, AR has the potential to spark the next big smartphone supercycle, and bring a whole new dimension to the mobile experience.