An UX discussion happened and the following solution was suggested in two steps

Step 1

Provide an extension point to contribute activity bar group (viewlet) and allow extensions to group views.
If there are multiple contributions with the same group id, last one wins

Advantages:

Extension can group the views they would like to have under single viewlet. This will work well with azure views.

Disadvantages:

Each Extension can create its own viewlet and there could be too many icons in the activity bar. This is mitigated by our activity bar that can scale.
User has no control to group or ungroup views. If two extensions contribute git related views under two different viewlets, then user cannot group them into one. If an extension contribute azure and docker views under single viewlet and then it is not possible for user to make docker as a separate viewlet.

Step 2

Ability to move views across groups . This is a big discussion scopes to complete VS Code.

Follow up tasks:

Start with Step 1: Create UI mock ups for contributing viewlets and get feedback from team and community

I would defer this to next milestone due to me being not available completely in this milestone.