Navigating Asia's new urban jungles

Selling into fast-growing cities will pose new challenges but bring big rewards.

Everyone agrees that Asia is urbanizing rapidly and that this trend will have a dramatic impact on economic development in the region. But unearthing tangible business opportunities in those markets will not be straightforward. Making money in and from Asia's cities is about to become a lot more complicated.

There are more Asian cities than outsiders tend to realize. Everyone has heard of Mumbai and Delhi, Beijing and Shanghai. But Johore Bharu in Malaysia, or Medan in Indonesia? The key to tapping urban wealth in Asia will be to look beyond first-tier megacities to the second tier of "middleweights" with populations of less than 10 million.

Development in that second tier is astounding. In India, Bangalore, Ahmedabad, and Pune together will have as many households earning $20,000 a year in purchasing-power-parity terms as Delhi and Mumbai by 2025. In China, 14 cities, including Wuhan, Xiamen, and Shantou, will have more households in this income segment by 2025 than Beijing and Shanghai do today.

So far, many Western companies have enjoyed great success mostly ignoring these second-tier cities and building strategies around a combination of developed Western markets and only the megacities in emerging markets. This relatively accessible combination currently accounts for about 70 percent of global GDP.

Over the next 15 years, however, developed economies and emerging megacities will account for only one-third of global GDP growth, according to a new McKinsey Global Institute report, "Urban world: Mapping the economic power of cities." Second-tier cities increasingly will set the pace. Around 230 middleweights that are not among the top 600 urban centers in terms of GDP today will make that list in 2025. Small and midsized cities with populations of 150,000 to five million will grow fastest. Some Western companies, such as Unilever, Yum! Brands, and Proctor & Gamble have started to understand this. Most haven't.

Middleweights will pose challenges even for companies that think they've mastered the business of developing economies by operating in megacities. Unlike high-profile megacities, middleweights tend not to be fully diversified urban economies. That means foreigners need a strategy for each individual second-tier city or region, instead of an overall "second-tier-city strategy."

Middleweights vary widely in their growth opportunities, consumption profiles, consumer attitudes, brand loyalty, and market dynamics. This is not precisely a new issue for many Western businesses, because such geographic diversification happens everywhere. America's southern Sun Belt, for instance, can be a profit center for companies serving retirees, while the language and cultural fragmentation within Europe can mean quite different approaches to different economies.

But figuring out where opportunities lie in Asian middleweights will be an order of magnitude harder. Emerging Asia lacks much of the infrastructure—transportation, communications, financial—that makes geographic fine-tuning easy in the West. Getting a product to Aksu in Xinjiang even over China's much-vaunted roads is more difficult than getting a shipment to Topeka, Kansas.

One way around this is geographic clustering, a mix between the scale economies of a megacity and the growth opportunities of a middleweight. The key here is to focus on regions where several middleweights are relatively near each other and have similar tastes. Foreign companies already do this in some emerging-market areas. Having established operations in Shanghai or Guangzhou, it's been simple to branch into other urban areas around the Yangtze and Pearl Rivers, respectively.

As urbanization proceeds and middleweights gain income, more such clusters will appear. Our colleagues have identified no fewer than 22 potential clusters in China and 14 in India. The clusters in India, for example, are likely to account for 17 percent of the country's population and 40 percent of its urban GDP by 2030.

These clusters, although still a challenge for businesses to understand, are at least more comprehensible than individual cities because the clusters demonstrate some common traits among their constituent middleweights. For instance, Shanghai has eight times the density of hypermarkets than the urban cluster in the middle to lower reaches of the Yangtze River. Consumers in the central-south region of the Liao River have three times the price sensitivity of their counterparts in the mid-lower Yangtze region and five times the impact of word of mouth on buying behavior.

All of these trends begin to suggest a way forward for companies looking to enter middle-tier cities. First, understand that just any city won't do. Managers need to find the right city or urban cluster for their company. Second, understand that what you think you know about a country based on your operations in its largest city may not apply in the second tier. Business planners will often have to start relatively fresh, learning about new marketplaces and consumers.

Companies need to make cities a central part of their thinking—that's a given. But the depth of knowledge that corporate strategists gather about the fast-changing urban landscape will be the key to their ability to tap this Asian growth opportunity.

Richard Dobbs is a director and Jaana Remes is a senior fellow at the McKinsey Global Institute.

Reprinted from Wall Street Journal © 2011 Dow Jones & Company.  All rights reserved.