By Vikas Kumar (The Economic Times - 26 November 2007)

Small is the new big. Small towns, that is. With demand nearly peaking in larger cities, companies are realising that there are plenty of untapped opportunities in the next level. And if you are small yourself, it could be the perfect alternative to taking your bigger competitors head-on or waiting until you are big enough.

A host of emerging companies in India are adopting this route to grow. They are starting small with tier II and III towns where the competition may not be as fierce, and entry barriers are lower. With rising real estate and manpower expenses, companies with limited resources have discovered that it’s a better idea to tap second and third rung cities because they offer lower operating costs and an audience that’s more ready to buy into their proposition.

Surya Foods and Agro, which started in 1993 as a biscuit manufacturing company is now a pan India foods player with an estimated turnover of Rs 400 crore this year. Founder and MD Ballabh Prasad Agarwala, who comes from a family business of biscuits manufacturing in Kolkata, chose smaller towns in North India to grow his network. From Noida, Agarwala tapped the UP market, later moving on to Punjab and Haryana, among other states. Today, the Priya Gold brand continues to be a North-centric brand with an estimated 30% share of the market according to Agarwala. However using its small town strategy, it has managed to establish itself in other metro markets like Delhi, as well.

Agarwal says the key has been in identifying gaps in the strategies of entrenched behemoths like Britannia and Parle: “Where they cannot reach, we have reached out to consumers with a more affordably priced offering, good quality and packaging. We launched our products with prices that were 30-40% lower than those of big brands.

Today, though we still don’t compete directly with them, we have established our presence in a significant way in the biscuits category,” he says. The company has since entered the packaged fruit juices category with its Fresh Gold brand, and very recently in the aerated fruit drinks segment with its Fresh Fizzy brand. Having filed the Draft Red Herring Prospectus with SEBI to raise Rs 136 crore from the markets, Agarwala is bracing for an IPO that could happen over the next couple of months.

Says Devangshu Dutta, CEO, Third Eyesight, a Gurgaon-based retail consultancy firm, “A number of companies and their founders are originating from small cities, unlike before. These players understand the socio-economic mileu better. There is also an underlying broadening of the consumer base due to improved socio-economic conditions.”

Another Kolkata entrepreneur who shifted base to Delhi six years ago has also been banking on small town India for business. When he launched his mass-market retail brand Vishal Retail in Delhi, Ram Chandra Agarwal was clear that his model would leverage the spending capacity and undertapped aspirations of consumers living beyond the metros.

So, nearly 80% of Vishal Retail stores – currently 70 and totaling 1.7 million sq ft under operation – are located in Tier II and III cities like Patna, Dhanbad, Haldwani, Ludhiana, and Bhubaneswar. “That has been our strategy from day one, as real estate and manpower costs are very reasonable in these towns and competition is less fierce, so we get the first mover advantage in establishing our brand,” says Agarwal, adding that smaller centres have been contributing significantly to the company’s revenues of Rs 603 crore (for 2006-07).

It’s not just in existing categories – companies in new categories are also venturing into the Indian heartland to capitalise on the business potential from small towns. Online DVD rentals company Seventymm.com, which was founded a year and a half back with funding from Matrix Partners, Draper Fisher Jurvetson and ePlanet Ventures, initially focused on the top six cities in India.

After fine-tuning its operations and acquiring the necessary learning from the metros, the company is planning its next phase of expansion into Tier II cities like Jaipur, Agra and Lucknow. Says its COO Subhanker Sarker, “Research shows that roughly 55% of C&S penetration in India is outside the top five cities. Since we are in the home entertainment business, a significant proportion of our consumers will come from those smaller cities.”

Earlier this year, Seventymm acquired Chandigarh-based competitor Madhouse Media, and Sarker says he’s now looking at a hub-and-spoke model to expand in new markets. So for instance, the Delhi hub will service cities like Jaipur, Agra and Lucknow, while Mumbai could cater to the Pune and Ahmedabad markets.

With a targeted turnover of Rs 100 crore from rentals within the next three years, Sarker says 25% of this is likely to come from Tier II cities. The company is investing in a robust delivery and collection mechanism, particularly reverse logistics – transportation of rented DVDs from customers back to the company – using its own trained personnel. While this infrastructure will help over the longer term, Sarker says there is one key difference in the way customers in smaller towns tend to transact.

"Based on our experience so far, we find that these customers are more skewed towards offline ordering and payment modes (as opposed to internet-based ordering and payment). So we’re exploring the possibility of setting up offline counters, possibly by partnering with modern retail chains, to address customers who are more comfortable with physical browsing and ordering of titles.” The home video market in India is estimated at Rs 600 crore annually, of which rentals presently contribute 50%.

Another beneficiary of this boom have been the real estate companies, which are making a beeline to smaller cities. Noida-based real estate company Assotech, which is building residential townships and commercial facilities for corporates in Ghaziabad and Gurgaon, is one such player. Its first hotel project— a 5 star —is coming up in Patna, in addition to several new projects in cities like Bhubaneswar and Gwalior. Chairman and MD Sanjeev Srivastava says, “We can’t compete with the entrenched players in the hospitality business in the metros. But in cities like Patna, they just can’t beat us.”

Even the aviation sector is taking wings in the newly opened regional routes that connect Tier II cities. And medium sized companies with little experience in aviation are entering the sector to tap this opportunity. In addition to the growing passenger traffic on regional routes, there are passengers who have to fly from smaller centres like Trichy or Coimbatore to Chennai to board an international flight. It’s this segment that new carriers like Air Dravida are planning to tap. Says Ramachandra Iyer, CEO, Air Dravida, “We are expecting the new international routes via the smaller cities to increase the international traffic by 20%, which gives regional players like us immense opportunities to operate profitably in the sector."