Growth Potential: Tier II and Tier III Cities in India

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7. Challenges

The consulting firm, Everest Group, has found that cost disadvantages and limited skill pool notwithstanding, first timers in India would be better off setting up shop in tier one cities. The additional investments these firms will have to make in training, infrastructure and management support will more than offset any savings, they say. So what are the challenges that setting up shop in tier II and III cities throw up?

Talent Pool and Labor Cost Savings:

IT/Outsourcing: According to the IMA report, labor cost savings has shrunk to just 5 – 10% of Tier I cities. The report indicates that Ahmedabad perhaps offers the best at 40-50% savings over costs in Tier I cities. Often, these savings are counterbalanced by heavier investment in training and the smaller talent pool to choose from. In fact, the Everest Group feels that in some of these cities (Indore is a case in point), one large player like Genpact or WNS would alone mop up all available talent. The silver lining around this particular cloud is the fact that attrition levels are also lower, at around 10% as opposed to the average 14-16% in tier I cities. The report indicates that balancing labor costs and availability of talent pool, Nagpur emerges as the best option.

Retail: For the major retailers, moving to tierII and III cities is really not a matter of choice – it is an imperative if they are to stay afloat and succeed in the great Indian retail race. In fact, this sector benefits by hiring locals, who come equipped with local knowledge. Labor cost savings are evident, especially at the lower levels. Getting the right talent middle management levels upwards would be slightly tougher, but not something that is impossible. However, training costs to bring employee skills up to speed would be a cost to be considered.

Real Estate:
These are very real concerns for both the IT/Outsourcing firms as well as retailers. Firms considering operations in tier II and III cities need to assess land availability, cost of acquisition or leasing, and development capabilities in these cities. Typically, IT firms and the big retailers prefer to acquire premises through the Built-to-suit (BTS) route. But increasingly there is a trend towards the ready-built version.

While real estate costs are rising everywhere, the rate of increase in Tier III cities is slower than that in Tier I and Tier II cities. Also, there is the quality of real estate development to be considered, because local developers tend to rate poorly. We believe this will change as more and more retailers and IT firms enter these markets.

Infrastructure:
This includes telecom service providers, power supply, connectivity via air, trains and roads and the general social and political climate. IT firms, BPOs and retailers would find that infrastructure they take as given in the tier 1 cities are bonuses in tier II cities and special privileges in tier III cities. For instance, Indore and Nagpur have relatively fewer telecom vendors. Kolkata and Chandigarh rate pretty high in terms of power supply, while the others lag. Education and healthcare are other major concerns – but do not pose too much of a problem in these cities. Another challenge is political stability – Kolkata does not have a great reputation here, while the others have a more stable political climate.

Retailers also face the challenge of poor infrastructure; weak supply chain and fraud or theft. They are also concerned about the social and cultural issues in these cities – after all adapting to new brands and formats is not something that can be done overnight. Kirana and textile storeowners in Gujarat, for instance, united together in a show of strength to stave off threat of the retail biggies. And then there is the consumer to reckon with – a whole separate issue to work on.

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