Valeant Pharmaceuticals did the impossible. Over the last few years, they have established themselves as a key player in the pharmaceutical sector without investing in research and development. Valeant’s past success was largely driven by a close alignment between its business model and its operating model, while their recent challenges have been related to a public that is not ready for their provocative approach to the business of healthcare.
A CONTROVERSIAL BUSINESS MODEL
Valeant’s business model is built around the acquisition of smaller pharmaceutical companies rather than through investing in research and development . This model is based on their observation that R&D has become a low-return proposition for many large pharmaceutical firms, who struggle to develop blockbuster drugs that can repay the $2.5 billion investment  required to bring a new product to market. Instead, Valeant creates value by identifying promising companies in attractive drug categories, acquiring them with the help of loans at historically low interest rates, improving efficiency through R&D cuts, and utilizing lower tax domiciles to house intellectual property . Moreover, Valeant often captures additional value by increasing the price of drugs that they view as underpriced, especially in smaller patient markets, where generic manufacturers are unlikely to compete .
A WELL-ALIGNED OPERATING MODEL
Valeant’s operating model is closely aligned with its business model, especially with respect to their allocation of R&D human capital, acquisitions-focused culture, and payables collection processes.
Valeant allocates significantly less resources on internal research and development compared to other large pharmaceutical companies, at approximately 3% of total revenue, compared to approximately 8% to 24% for many large pharmaceutical firms (Figure 1). On the other hand, Valeant pays approximately 12% of its total revenue in interest expenses, largely as a result of financing its acquisitions through loans. This outcome is driven by their operating principle to focus on bringing new products to market (output), not R&D spend (input) . Their limited R&D spending is devoted to line extensions and late-stage development programs, which have a higher probably of success.
Figure 1 – Comparison of three cost drivers for several major pharmaceutical companies .
The acquisition processes at Valeant are also highly aligned with their business model. Their operating principle  is to target high-growth business segments, both in terms of therapeutic areas and geographies. Specifically, Valeant has targeted North America and emerging markets, such as Asia, Latin America, Central Europe, Eastern Europe, Russia, and North Africa. Their acquisitions team focuses on completing a high volume of deals, at approximately 25 per year, including many deals too small to report financially .
Valeant’s operations related to cash collection are also aligned with their business model. They are concerned with government-driven price decreases, which impact their business strategy of acquiring underpriced drugs and subsequently increasing their prices. To avoid this risk, they focus on providing products in less price-sensitive markets and have achieved over 75% of sales through cash pay or reimbursement through private insurance .
AN UNCERTAIN FUTURE DESPITE CLEAR ALIGNMENT
The close alignment of the operating model with the business model creates a competitive advantage for Valeant. Their low investment in R&D human capital, culture of acquisitions, and cash collection processes enable their business strategy of acquiring promising drugs, reducing costs, and increasing prices. Their business strategy, however, continues to face criticism (see video below). Public condemnation related to their strategy of increasing drug prices has caused the public to be suspicious of their other activities. For example, in October 2015 the short-selling research firm, Citron Research, accused Valeant of nefarious accounting practices, which decreased investor confidence in Valeant management and led to a deflated stock price ($257 in July 2015, $70 in November 2015) . Furthermore, Valeant’s business model is dependent on their ability to continue to complete large acquisitions, which will become increasingly difficult as their reputation for cost-cutting spreads, as evidenced by their failed acquisition of Allergan in 2014 [9,10]. Moreover, Valeant’s strategy is dependent on the availability of low interest rates, which may change if investors begin to question the sustainability of this business strategy. While it is clear that there is alignment between business and operating models, it is less certain whether Valeant will be perceived by the public as a cleverly-structured provider of pharmaceuticals or as opportunistic middlemen for necessary medicine.
Figure 2 – Video of Aswath Damodaran, professor of finance at NYU, discussing Valeant’s business model with Bloomberg’s Joe Weisenthal, Alix Steel, and Scarlet Fu .
 Udland, M. (2014) “VALEANT: How a Canadian Pharmaceutical Company Could Destroy The Industry As We Know It.” Business Insider. Accessed: 12/08/2015. Available online at: http://www.businessinsider.com/valeant-business-model-2014-6
 Mullin, R. (2014) “Cost to Develop New Pharmaceutical Drug Now Exceeds $2.5B.” Chemical and Engineering News. Accessed: 12/09/2015. Available online at: http://www.scientificamerican.com/article/cost-to-develop-new-pharmaceutical-drug-now-exceeds-2-5b/
 Goldfarb, R.D. and Poppe, D.M. (2015) “Letter to Clients and Shareholders.” Business Insider. Accessed: 12/08/2015. Available online at: http://www.businessinsider.com/sequoia-losing-on-valeant-stake-2015-10
 Helfand, C. (2015) “Valeant CEO defends price hikes, business model in letter to worried employees. Accessed: 12/08/2015. Available online at: http://www.fiercepharma.com/story/valeant-ceo-defends-price-hikes-business-model-letter-worried-employees/2015-09-28
 Valeant. (2013) “Shareholder Letter”. Valeant Investor Website. Accessed: 12/08/2015. Available online at: http://s1.q4cdn.com/484041954/files/2013_AR/letter-to-shareholders.html
 Graph generated in Microsoft Excel using data obtained from http://finance.yahoo.com/
 Wayne, A. (2013) “Valeant Agrees to Buy Bausch & Lomg in $8.7 Billion Deal.” BloombergBusiness. Accessed: 12/08/2015. Available online at: http://www.bloomberg.com/news/articles/2013-05-27/valeant-agrees-to-buy-bausch-lomb-for-4-5-billion-cash
 Gara, A. (2015) “Valeant Plunges 30% After Short Seller Citron Research Makes Fraud Allegation.” Forbes. Accessed: 12/08/2015. Available online at: http://www.forbes.com/sites/antoinegara/2015/10/21/valeant-plunges-30-after-short-seller-citron-research-makes-fraud-allegation/
 Lachapelle, T. (2014) “Is Valeant’s Buy-to-Grow Strategy Sustainable?: Real M&A.” BloombergBusiness. Accessed: 12/07/2015. Available online at: http://www.bloomberg.com/news/articles/2014-05-26/is-valeant-s-buy-to-grow-strategy-sustainable-real-m-a
 Nickel, R. and Oran, O. (2014) “Losing Allergan deals blow to Valeant reputation.” Reuters. Accessed: 12/09/2015. Available online at: http://www.reuters.com/article/us-allergan-m-a-valeant-pharms-idUSKCN0J121520141117
 Damodaran, A., et al. (2015) “Is Valeant’s Business Model Broken?” BloombergBusiness. Accessed: 12/06/2015. Available online at: http://www.bloomberg.com/news/videos/2015-11-11/is-valeant-s-business-model-broken-