What can the legal sector learn from the crisis at Valeant?

What can the legal sector learn from the crisis at Valeant?

Lawyers often say they wish they had more input into how to run their businesses from people who are not lawyers, or former lawyers. This is because they feel they benefit from learning how other businesses do things. One such example of a company with a lesson attached is that of the troubled North American pharmaceutical company Valeant.

Fundamentally, Valeant and its current crisis, which is now filling the front pages of the business press on both sides of the Atlantic, is a story of losing sight of the key purpose of the company, that is to say losing sight of making the best possible product for its customers.

What did Valeant do?

Valeant became a global pharma company in the 1990s through a series of combinations with other large pharma businesses. Scale helped it to compete with rivals and its greater revenues also helped to fund the vital research and development (R&D) of new and improved products that would make their customers’ lives better. As one can imagine, developing new drugs to sell to customers was the “base of the pyramid” in terms of running the business. No new drugs to sell = no future business.

But, then some new managers at Valeant had a bright idea, or so they thought: there is no need to develop new products, we will slash research spending and use the extra cash to buy up other pharma companies and the products they already own.

The argument went: why innovate, why spend time nurturing our talent, why invest our own money on building something when we can just build a conglomerate based on other people’s past efforts?

The result would be a much larger business with far lower research costs. It also practised the art of price gouging on its key drugs. Why? Just because it could as it believed it had a monopoly on those kinds of products. And it moved its HQ to Canada primarily to lower the tax it paid in the US, not for any customer-related purpose. A genius strategy some believed. And its share price rose rapidly as belief in the strategy spread through the market (see Table 1).

Valeant Shares

Table 1: The 'normal' Valeant share price, the peak price due to the new strategy and then the aftermath.

What was the problem?

The problem was this: Valeant moved from being a business whose end customers were people who needed their well-made and cleverly designed drugs to cure them, to becoming a business whose most important end customers were shareholders, especially those in its own top management who saw the value of their significant options rise dramatically every time it bought out another company, or slashed their R&D investments.

Valeant is not exactly another Enron, but its shift in core strategic focus from respected supplier to self-interested profit maker is very similar. Though Valeant has not (yet) imploded like Enron, it certainly doesn’t look good.

The company has recently faced several investigations from US authorities, senior staff have left the business, external shareholders have engaged in angry disputes over strategy and the company’s share price has fallen from a high in $257.5 in July 2015 to $29.9 March 2016, or a loss of nearly 90% of its value. In fact, the company is worth what it was worth back in the early 2010s, before the “profit-first” strategy fully took over.

What can law firms take from this?

The fundamental lesson here is that businesses that lose sight of who they are trying to serve may seem like they are doing well, for a time. But, eventually the end customer always realises the truth. And they realise the truth because unlike those who sit in boardrooms they experience first-hand what the company is producing, how it treats them and how much it charges them.

In any business one can game the system to produce higher profits. Law firms can keep cutting away at costs to the point where it harms future growth and the ability to provide a premium service; the equity can be held very tightly whether this is justified or not, or equity points can be tilted to reward those who got there first far more than is justified; and firms can also outsource key business support functions to people who have no loyalty to the firm. There is no end to the ways a firm can boost profits and shoot itself in the foot at the same time.

But, as with Valeant’s external shareholders and drug purchasers, law firm clients are no suckers. They will pay high prices for “goods” that are valuable and not easily offered by others. They don’t mind seeing the providers of their services get rich, as long as they feel they have been enriched in some way at the same time – in a law firm’s case by giving great legal advice and support that makes a material difference to the client in a memorable way.

How should law firms respond?

The key point here is not that growth, or even very rapid growth, is a bad thing. The issue is that any business strategy that doesn’t first seek to better help the client is going to “hit the buffers”.

Size, or seeking to build scale, is not the problem. Some very small firms are actually doing their clients a disservice by not providing the breadth of capability the clients need. They are also holding back the talent they have hired by not growing in order to keep the equity pot in the hands of the few. Staying small and not acting in the best interests of the clients is just as weak a strategy as growing through massive mergers that are first designed to boost revenue that will feed back to the partners’ bottom line. The legal market has seen both.

In short, the problem is placing profit before product, or in the case of law firms: profit before service.

Businesses of all types do well when they focus most on what clients want. The key challenge to any strategy is always to ask whether it is primarily focused on providing clients with the best possible offering, which in turn will generate healthy returns for you if done right.

Or, is the strategy focused on getting the business to a point where it first provides a healthy return whilst at the same time hoping the clients stay loyal even though they may see no significant improvement in the offering, or perhaps even see a decline in value when compared to what your rivals are offering?

Valeant chose the latter. It hasn’t gone well.

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About the author:

Richard helps law firms with important strategic decisions. He advises on areas such as merger, practice development and geographical expansion. He also provides assistance to law firms in relation to organisational and operational issues.

Richard has spent over 16 years working in the legal sector focused on the UK and global legal markets. He previously worked at Jomati as a strategy consultant and authored the Jomati Report series between 2009 and 2014.

Prior to that, Richard worked at US-based, Hildebrandt International, and also held senior, legal sector editorial roles in London and Paris.