Meta’s Virtual Reality Meets Facebook’s Harsh Real World

And yet, business was still booming. The company’s advertising revenue for the trailing 12-month period ended September 2021 was up 42% year over year—the best growth rate in more than three years. Operating margins were also comfortably back above the 40% mark for the first time since 2018—and 10 percentage points higher than what arch-rival Google was generating at the time.

But that was before a series of events combined to slow the global economy and cripple the online advertising market. That has cast a shadow over the company just as it makes its most ambitious attempt yet to prove that its metaverse aspiration actually has some legs. Meta will lift the wraps on its latest efforts in virtual reality next week, just as it is also working through an extensive cost-cutting effort that involves office closures, hiring freezes and staff cullings that Meta is taking some pains not to describe as layoffs. The stock has lost 58% of its value over the last 12 months—the tenth worst performer on the S&P 500 in that time.

Revelations at the “Meta Connect’’ conference starting Oct. 11 are unlikely to turn around that sentiment. The company is expected to use the event to introduce a new, high-end VR headset; one that Mr. Zuckerberg previously described as being designed for “work use cases and eventually replacing your laptop or work setup.” And the company at least has some positive momentum to build on, given strong sales of its Quest 2 VR headset that launched in late 2020. That device is designed mostly for videogaming and sold nearly 8.8 million units last year—more than the total number of headsets sold by Meta for the previous five years combined, according to estimates by IDC.

But success in VR is a highly relative concept, as even gamers have been lukewarm on the technology. Total revenue from VR games last year was $1.5 billion—less than 3% of the total revenue generated by console games for the year, according to market research firm Newzoo. And while Meta now dominates VR with about 88% share of the global hardware market for the first half of this year, according to IDC, the Reality Labs business segment that includes VR made up just 2% of the company’s total revenue in that time. That unit also lost nearly $5.8 billion in the first half of this year.

Which means that Facebook’s transformation into a metaverse company still relies on ads. And that business is facing its most significant challenges to date. A global economic slump has come just as the company is dealing with the impact of privacy changes on

Apple’s

iOS platform and growing competition from TikTok. Meta reported its first-ever drop in advertising revenue for the second quarter on a year-over-year basis, and Wall Street is expecting declines to persist for the second half of this year, according to FactSet.

That has resulted in an unprecedented bout of belt-tightening. Mr. Zuckerberg told employees last week that the company will be implementing a hiring freeze, which followed a report by The Wall Street Journal that the company is looking to cut expenses by about 10%. The company is also working to shrink its real estate footprint as more employees work from home, though it hasn’t yet quantified how much.

Other tech giants are also taking actions to manage their costs, providing a reminder that even the most powerful, cash-rich businesses aren’t immune to recessionary forces. But Meta’s big tech peers are also not in the midst of an ambitious business shift. Mr. Zuckerberg’s vision to bring the metaverse to a billion people is an expensive one; the company has maintained its target of spending up to $34 billion in capital expenditures this year, which is double what it has averaged over the past three years.

So having less money coming in the door is a problem. Meta is hardly about to dip into the red; Wall Street’s projection of 28% operating margins for the next three years is still about 5 percentage points above the S&P 500’s average, according to data from S&P Global Market Intelligence. But that is from a company that has averaged annual operating margins of 40% since the year after it went public in 2012. And even if Mr. Zuckerberg succeeds in convincing the masses to try out its metaverse concept, the business models there remain uncertain—especially with world governments now eyeing his company closely. The former Facebook’s real world will long haunt its virtual one.

Write to Dan Gallagher at dan.gallagher@wsj.com