Healthcare was once a stellar performer at the Bombay Stock Exchange, consistently outperforming the benchmark bourse six-fold over the last five years, but it has started to lose some of its sheen. The industry is facing greater pressure on margins and this will continue into the future, after several years on the crest of strong domestic growth.

The reasons are plenty. Structurally driven inflation, salary increases, high interest rates and a weakened rupee have resulted in ballooning medical costs. But due to the economic slowdown and increasingly price-conscious customers, it is getting more difficult to pass on price increases.

These headwinds are buffeting all sub-sectors. Healthcare providers are faced with rising wages due to a shortage of qualified nurses and doctors. Medical equipment companies are struggling to cope with a weak rupee that is pushing up the cost of imports, which make up nearly 70 per cent of their supplies. Pharma manufacturers are concerned about looming price control legislation threatening to curtail price growth—the government took a major step recently by deciding to cap prices of essential drugs which, by some accounts, make up 60 per cent of the domestic market. This will affect 348 drugs worth around ₹290 billion. The government’s $5.4 billion plan to provide free generic drugs to state-run hospitals will be another challenge for the pharmaceutical industry. That programme will impact the profits of manufacturers of branded medicines, something they must plan for while, working with authorities to ensure quality medicines at affordable prices.

Despite all these existing and new challenges, the long-term opportunity is attractive. We estimate the Indian healthcare sector will expand dramatically over the next decade, growing at an annual rate of 14 per cent, with the larger players expected to grow faster. To capitalise on this projected growth and ride out the current turbulence, firms must ensure that they have an effective business model to scale in a cost-efficient manner.

To do so, participants in the healthcare sector need to scrutinise costs beyond just incremental, targeted techniques such as trimming indirect costs, outsourcing business processes and using Lean Six Sigma to eliminate waste. These work in normal circumstances, not in a climate of disruption currently roiling India’s healthcare sector.

Clearly, a more comprehensive approach is needed here. And zero-based budgeting (ZBB) provides a practical way for healthcare companies to radically redesign their cost structures, cutting as much as 25 per cent of spending on overhead and support functions, while boosting efficiency and competitiveness.

This broad-reaching approach to cost transformation differs from targeted cost cutting in several ways (see visual). It starts by re-envisioning the business and asking what activities and resources are needed, as opposed to what needs to be trimmed or removed. ZBB examines every area of spending with a more complete set of tools than targeted cost cutting. The approach analyses which activities should be performed at what levels and frequency, as well as how they could be better performed—potentially moved offshore, outsourced, streamlined, standardized or automated with refined organisational structure and responsibilities.

ZBB strengthens capabilities that provide true competitive differentiation, while intentionally downgrading others that over-deliver on noncritical functionality. Because ZBB also involves finding the root cause of the costs, there is less risk of unintended consequences for companies who want to redesign pared-down activities. Finally, ZBB is done in one comprehensive effort, rather than successive rounds of targeted cost cutting that can drain employee morale.

This clean-slate approach to cost reduction can be daunting. However, we have found that companies which transform their cost structure through ZBB generally follow a common set of actions:

Build a dedicated ZBB team, supported by the entire organisation.

Form a core team of experienced project leaders from various functions, reporting to a corporate steering committee and an executive sponsor. As the programme gains momentum, more people take part, with as much as 5 per cent of the staff providing input. ZBB is not a hands-off exercise.

Begin envisioning the ideal state by calibrating function missions.

Redefine each function’s mission to set and achieve an ambitious cost target—large enough to ensure transformational rather than incremental thinking. For example, a finance function’s mission might shift from ‘providing world-class financial support’ to ‘providing efficient low-cost transactional support while also providing top-quartile decision support services’. Benchmark business units, regions and peers—envision each function in an ‘ideal state’ starting with a blank sheet of paper, identifying service levels that can be reduced or removed to match evolving company needs.

Establish savings potential, and assign priorities by comparing the existing state with the ideal state.

Compare existing baseline for all costs and processes with the ideal state, to identify savings opportunities, associated risks and costs of transformation. Then assign priorities to each opportunity based on its size and the difficulty of achieving it.

Build pragmatic view of future from the bottom up to set savings commitments across the firm.

Develop a thorough and pragmatic version of the ideal state, taking into account practical constraints like transition costs and risks. Design the organisation needed to support the future state, ensuring that the design is consistent with best practices for spans, layers and effective decision making. Working from the bottom up, project future costs and resources for each prioritized activity, yielding firm cost and savings commitments.

Create an implementation plan and PMO.

Establish a quarter-by-quarter implementation plan, including an implementation team, and create an internal and external communication plan. Set-up a new Programme Management Office (PMO) to champion and communicate achievements, monitor savings, embed new capabilities and sustain the cultural change.

The effort may sound intimidating, but the actions build on one another in a systematic way, resulting in a focus that typically achieves dramatic transformation. Let’s look at the recent experience of one medical technology company.

The company had been struggling to contain overhead costs, and operational complexity was hampering its ability to respond to customer and stakeholder needs. This was most apparent in its IT department. During the boom years, as the size and global reach of the company grew, so had its IT spending. The IT department created a ZBB team. After taking into account industry benchmarks, future needs and the revamped strategic agenda, it set the goal of reducing IT costs by 25 per cent. The company dissected its entire it function, ultimately halting some activities and projects, decreasing service levels on others and redesigning processes that helped it reach maximum efficiency.

Armed with a future state and an organizational framework that reflects the new vision, the IT department is now a step ahead on its plan to reduce spending by 25 per cent, free up resources and improve effectiveness in critical support areas. The company also brought its quality function through the ZBB process, identifying saving opportunities of over 20 per cent. It then built a repeatable model, running various departments through the same process.

For companies in India’s increasingly turbulent health sector, it’s time to pick up a blank sheet of paper and build a future state—now.

Karan Singh is head, Asia-Pacific healthcare practice, Bain & Co, and based in New Delhi. Paul Cichocki and Molly Kerr are partners in Bain & Co’s Boston office. They are members of the firm’s ‘performance improvement & healthcare practices’.