Driven by lower operating costs and incentives in the form of tax holidays and

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subsidies by state government, smaller cities like Jaipur, Chandigarh and Mysore have emerged as lucrative destinations for IT and BPO firms.

According to the Q2 report by Everest Group on global sourcing, IT and BPO companies are looking at tier II locations in the country to support global delivery.

Locations such as Jaipur, Chandigarh, Mysore and Nagpur are being increasingly leveraged by service providers to expand their offshore operations, it added.

"Lower operating cost of tier II and III cities (compared to established locations such as Bangalore) and additional incentives by state government for investment promotion have prompted service providers to expand their offshore operations to smaller cities," Everest Group Vice President Amneet Singh told reporters here.

The report cited examples of companies such as Deutsche Bank and Genpact, which have set up their offshore operations at Jaipur, while Dell and EDS-Mphasis, which have opened centres in Chandigarh and Ahmedabad respectively.

However, this growth has been mainly restricted to third-party suppliers.

Company-owned units (captives) continue to prefer tier-I cities due to their enhanced infrastructure, commuting facilities and overall better quality of life.

Captives are business units of a company that function offshore as entities of their own, while retaining close operational tie-ups within the parent company.

India has retained dominance in the captive space with 37 per cent share. Of the 38 new announcements this quarter, 14 of these set-ups were made in India.

Speaking on the global market, Singh said that outsourcing and offshoring services remained on a growth trajectory Q2 of 2010, on the back of robust transaction and captive activity.

"The market continues to grow on the back of transaction volumes and positive traction in the banking, financial and insurance (BFSI) verticals," Everest Group Principal and Country Head India Gaurav Gupta said.

Even though some geographies and industry verticals like manufacturing witnessed lower activity during this quarter, the overall outlook remains fairly optimistic, he added.

While the outsourcing market grew by 12 per cent quarter-on-quarter with 498 reported transactions, the BPO market increased by 15 per cent and 33 per cent in transaction volume and annualised contract value terms respectively.

The report includes data from 20 companies, including Accenture, Convergys, Hewitt, IBM, Dell Services, Cognizant, Genpact, HCL, Infosys, Mahindra Satyam, TCS, Wipro and WNS.