I'm theorizing that the VCs believed that the fact that the big companies did not make any such product proved there was no profitable demand for it, because the market worked.

That doesn't look like a viable hypothesis because if it were true, such people would not be VCs at all.

Generally speaking, you seem to expect perfection in business agents. Clearly, this is not so in reality. "The market" is not each individual agent, it is the sum of them all. Moreover, the market works by self-correcting which implies that there are a LOT OF MISTAKES being made all the time. The market is successful because it provides negative feedback to those who make mistakes, so on the average it does what it does quite well, but it would be an error to think that each individual decision is optimal.

The market failure is that competition has not driven the cost down close to the cost of production.

Nope. Reality is primary, theories are secondary. In real life the markets drive the price down to the cost of production only occasionally. If your theory says they should, it's the theory that needs to be adjusted.