Even as the Indian IT services industry has not been able to make much inroads into the tier-2 and tier-3 cities, many software product development companies incorporated in recent years are banking on smaller cities to minimise operational costs.

By operating out of smaller cities, most of these software product start-ups -- led mostly by first-generation entrepreneurs -- want to minimise their cost of operation during initial days. This helps them significantly, as the gestation period for product companies are considerably higher when compared with the IT services companies. Besides, these companies manage to attract good talents in these towns at a comparatively lower price, according to industry analysts.

According to various industry reports, the start-up activity in Indian IT space has witnessed rapid growth with more than 1,100 start-ups being incorporated in the past five years. The studies say that of these, over 330 companies are based out of tier-2 and 3 cities such as Belgaum, Madurai, Coimbatore and Thiruvanthapuram.

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IBS notes that there are "lots of innovations" happening in smaller towns and the sustainability rates in these towns are higher than the bigger cities.

"The main reason is the cost advantage which will help them to pass through the gestation phase," notes V K Mathews, founder and executive chairman of the product company located in Thiruvanthapuram.

Take for example the case of Vayavya Labs, an embedded software tool developer. Founded in 2006 by a team of four engineers, the firm counts technology companies like Trident, Synopsys, NDS and Electra Plc as its customers. Technopark, an IT park based out of the Kerala capital, houses around 70-75 software product companies. Located across 360 acres, Techno Park houses a total of over 230 companies.

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Smaller cities adopting the product route than the traditional services route is an advantage, notes Sharad Sharma, chairman of Nasscom product forum.

"The problems they see and the way they try to solve it is real innovation. This will help the growth of product ecosystem in smaller towns. This will create clusters in the country."

He is confident that, slowly, with various steps taken by the industry, more companies like Fusion Chart, Zoho and IBS will evolve from smaller towns. The software product market in India is estimated to be worth $2 billion (approximately Rs 10,500 crore). There are about 2,400 software product companies in India.

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Some of the challenges that small companies face are finding right customer and marketing. However, the great advantages of smaller towns are that most of the companies are located closely and act as a cluster to develop the location.

"There was a notion that smaller companies located in small cities are finding it difficult to market their products," recalls Kathir Kamanathan, CEO of Chella Software, a Madurai-based company that develops software products for capital markets.

"But with the availability of various technologies, we can now reach any part of the globe."