China's smaller cities and towns are offering the greatest potential for retail growth in the years ahead, due to the country's quickened urbanization and rising income in rural areas, the Nielsen Company said on Tuesday.

According to Nielsen, lower-tier cities (referring to county-level cities) currently account for 87 percent of China's population, but just 64 percent of retail sales.

"A population of 1.3 billion where about half live in 570,000 rural villages represents enormous untapped potential. And the growth rate in lower-tier cities in the following few years will be twice what it is now," said Mitch Barns, president of Nielsen's Greater China.

The accelerated growth rate is driven by the quickened urbanization and rising income in rural areas.

China's urbanization rate will hit 52 percent in 2015 and grow to 65 percent by 2030, according to the annual report on urban development by the Chinese Academy of Social Sciences. By the end of last year, the urbanization rate had already reached 46.6 percent, with 620 million people living in cities and towns.

Xu Shanda, a member of the Committee for Economic Affairs of the Chinese People's Political Consultative Conference, said the government will take a slew of measures in the coming years to improve the earnings of low-income families to stimulate domestic consumption.

For Barns, companies' major challenges in tapping the country's lower-tier cities are the diversity, as consumers' taste and culture background differs largely from city to city.

"Superior, in-depth local consumer understanding is key to success for both local companies and multinationals, as the retail environment is diverse and the competition is intense," Barns said. "Meanwhile, the supply chain and execution capacities are also two factors that can differentiate companies exploring these lower-cities' markets."

One area that stands out for growth in China is automobile sales. Over the past five years, China was the only country in the world to achieve annual growth of more than 20 percent. In 2010 alone, car sales are likely to grow by 23 percent, according to Nielsen's estimates.

The big story, however, is not how much car sales will consistently grow in the next few years, but where that growth will be coming from: China's lower-tier cities.

"Private vehicle ownership is still low in China, and we expect that the number of first-time car buyers will increase sharply in the next few years," said Shirley Ng, a director in the automotive division of Nielsen China.

Car owners in first-tier cities like Shanghai are starting to trade up - good news for luxury models. But the real opportunity is in the tier two, three and four cities in provinces such as Shandong, Fujian and Guangdong, where the middle class is growing every year and their confidence as consumers has been rising faster than in tier one cities, she added.