India’s Tier II and Tier III cities – are you missing the bus?

In March 1994, the Indian domestic aviation sector was opened up, allowing for scheduled services by the private sector.   One major caveat was introduced.   Private airlines would only be able to ply between India’s lucrative major cities provided a certain number of flights in their portfolio covered the, less lucrative, smaller cities as well.  Grudgingly, operators complied.

Fast forward to 2010.  Much mention is being given to urbanisation in India. How there are currently 42 cities with populations of more than 1 million, compared to Europe’s 35.  How the annual income of households in cities is expected to rise from about US$700 billion today and double every five years and reach almost US$4 trillion in 20 years. The late Prof C K Prahalad, one of India’s most eminent management gurus, was renowned for his clarion call on the need for India to create 500 more cities by 2022 to absorb the shift in migratory patterns and developmental needs in terms of jobs, access to markets and infrastructure.  

Which are the sectors which have been, or currently are, making big bets and driving growth in the Tier II and Tier III cities? Below is a snapshot analysis.

1.  Infrastructure: It is estimated that India needs to invest US$1.2 trillion in urban infrastructure capital over the next 20 years.  According to the McKinsey Global Institute (MGI), India’s tier II cities will need $200 per capita per annum expenditure on urban infrastructure over the next 20 years, compared to the national average requirement of $134 per capita per annum. In terms of connectivity, the Government of India has embarked on an ambitious National Highway Development Programme.  It aims to develop more than 50,000 km of national highways in seven phases.  The map of projects completed under the NHDP in the last 10 years can be seen here.

2. Travel and Tourism: In many ways, a bellwether of economic development, this sector has traditionally been a significant growth engine for India’s smaller cities. Be it for business or leisure, the travel and tourism industry has served to provide critical basic infrastructure, creating a demand-pull for greater connectivity.  With prohibitively high costs of real-estate in the Tier I cities, more and more high-end hotel chains, such as the Marriott, are extending their attention and presence to the needs of the Tier II and Tier III cities.  Interestingly, reverse flows are also being explored.  The Singapore Tourism Board has recognised the untapped potential of these markets and launched a campaign to woo tourists from these Tier II cities to the city-state.

3.  Real estate: The availability of land at affordable prices in these cities, backed by the demand for organised realty, is proving to be pivotal to the success of real estate in Tier II and Tier III cities. According to Ernst and Young (E&Y), several Indian cities with a population of 0.5-1-million will emerge as the most promising market for residential and retail developments, within the next 3-5 years.

4.  Retail:  Of the 80 million households that constitute the Indian middle class, only 25 million are in Tier I cities. Close to 55 million belong to the smaller towns.  According to a study of 100 cities’ consumption spending by Indicus Analytics, only 30% is accounted for by Tier I cities.  With the growth of organised retail, franchising is also booming in untapped Tier II and Tier III cities, showing a phenomenal 40-45% growth in the $16 billion Indian franchising industry. Some of the world’s multinationals have cottoned on to this potential. Earlier last month, Canon India said that it would be aggressively looking at Tier II and Tier III cities, which are expected to generate 70 per cent of its business (currently US$267 mn) by 2015. According to Mercedes-Benz, there is a possibility of 15-20 per cent sales coming from tier-II and III towns. Mercedes already sells more cars in Ludhiana than in Mumbai. Bose Corporation, Adidas, Bacardi, Daikin, Panasonic are some other well-known names placing big bets on these smaller cities.

5.  Education: Anyone familiar with India’s engineering powerhouses, the Indian Institutes of Technology (IITs), should probably be familiar with the city of Kota, the national hub for student coaching.  Today, coaching is the lifeblood of the Kota economy and contributes more than $100 million, from insignificant sums two decades ago.  This is just one example. The reality is that 600 million Indians are under 25 years of age. By 2015, more than 550 million will be teenagers. The total labour pool that will require advanced training in vocational, managerial, IT and other skilled and semi-skilled professions is expected to exceed 30 million individuals per year through 2020.   

6.  IT and Business Process Outsourcing: According to a recent study, India's business process outsourcing industry has the potential to rise nearly five times to US$50 billion in revenues by 2012, provided it successfully taps talent in smaller cities and town, a global consulting firm said.

As per the MGI study, India will have 68 cities with a population of more than 1 million, 13 cities with more than 4 million people, and 6 mega-cities with populations of 10 million or more, by 2030.  

Are you positioned to garner a slice of the pie?