The Top 10 Vendor Risks & How to Manage Them
Increasing globalization, a heavy reliance on outsourcing, growth of cloud computing, and the transition to digitization and remote work since the COVID-19 crisis have each heightened the regulatory focus on vendor risk management (VRM).
Does your organization have the proper systems and controls in place to face these challenges?
VRM helps your organization understand vendor risks and provides the tools to evaluate, monitor, and mitigate them. An effective VRM program can be configured for specific activities across your organization and help strengthen the business overall.
There are certainly benefits to outsourcing to third-party vendors: expertise, avoiding training of new employees, reduced spend, and increased efficiency. But you need to be cautious when onboarding vendors, because you are liable for their failures and disruptions. Perform the necessary due diligence, audits, and risk assessments to avoid these critical risks prior to onboarding and continuously throughout the vendor relationship.
The top 10 critical risks to be prepared for
Why is vendor risk management important? A robust VRM program can you help prevent or mitigate the ten critical risks listed below, along with some of the more specific risks that fall under each (and there are more arising all the time):
Compliance/Regulatory Risk is the risk that a third-party vendor will violate a law or regulation that you’ve contractually obligated them to follow. Vendors must be in compliance with laws, regulations, and rules passed down by regulatory bodies that affect your company and industry, or an institution’s own internal policies. Failure to meet compliance standards can result in enforcement actions, harsh fines, and a blow to your company’s reputation.
- Bank Secrecy Act (BSA)/Anti-Money Laundering (AML) and Office of Foreign Assets Control (OFAC) Risk arises from your vendors working with criminals or terrorists. It’s especially important that your business prioritizes BSA/AML and OFAC compliance, because the consequences could be much worse than fines or sanctions.
Information Security/Cybersecurity Risk includes data breaches, ransom, and malware and cyber events that are becoming increasingly more common. All companies — including large financial institutions, small community banks, healthcare companies, credit unions, power generation utilities, manufacturers, and retailers — are at risk. This danger has become even more prevalent since many businesses have moved to remote work and started relying on unsecured access to servers and video conferences.
- Software-as-a-Service (SaaS)/Cloud Risk is similar to information security risk, but it is specifically related to information that only exists in an online, digital form. Cloud risk is an important emerging area of VRM because many businesses have shifted away from on-premise data centers toward storing data in the cloud. There are obvious benefits: reliable and convenient access, increased delivery time, consistency, and affordability. Security risks became a factor, however, due to:
- Poor security practices
- Compliance violations
- Application vulnerabilities
- Malware infections and data breaches
The result, much like cybercriminals attacking a corporate data center, is reputational risk, tarnishing your brand, and potential revenue loss.
Reputational Risk is, as already mentioned, your company’s image being ruined in the minds of consumers, the media, investors, and the public. This dissatisfaction can result from many things: a lack of deliverability, a drop in quality, bad customer service, inappropriate workplace behaviors, and security breaches.
Environmental, Social and Governance (ESG)-Related Risks relate to sustainability, such as a vendor’s carbon footprint, how they manage water and wastewater, etc.; reputation or brand; legal; technological; compliance; and product or service quality. Vendors acting irresponsibly with the environment and workplace safety practices can pose sustainability, non-financial, or extra-financial risks to your business.
Transaction Risk stems from vendors failing to deliver promised services or products. If a software or IT vendor can’t keep your servers or hardware running, or you keep experiencing glitches, then you need to assess the long-term relationship with a vendor.
Operational Risk ties back to inadequate or failed internal processes, people, and systems. It can also be impacted by external events. Your organization, or a segment of your organization, could experience a major workflow or production shutdown if a vendor’s processes, workforce, or systems fail.
Geographical Risk is the location of your vendors having an impact on your business. Conducting business with vendors in other countries means complying with foreign standards and regulations. For example, General Data Protection Regulation (GDPR) and its protections on privacy and data has become a great concern for anyone who has dealings with European businesses.
- Geographic Concentration Risk is an organization’s overreliance on a single vendor or vendors in a geographic region. If you outsource to a single vendor for multiple critical business services or to several vendors near one another who use the same fourth-party vendors, you’re exposing yourself to potential impacts from natural disasters, pandemic outbreaks, and political upheaval in that geography.
Financial Risk is the potential negative financial impact on your organization due to a vendor relationship. Your company could fall short of fiscal-year or manufacturing quotas if a supplier or subcontractor provides low-quality parts or services. Damage to your financial performance can impair an organization’s ability to pay off debt or deliver value to shareholders.
- Credit Risk is the risk that a company’s financial strength or ability to manage debt will hurt operations. You want to avoid doing business with a vendor with a history or bad financial decisions and a poor credit rating.
Strategic Risk directly results from adverse business decisions or in inconsistency with business practices and stated strategic goals. Strategic risks have become particularly urgent due to rapidly evolving business and market trends, technological innovations such as the Internet of Things (IoT) and Big Data, and a swift reevaluation of workplace best practices due to COVID-19.
Contract/Legal Risk is when a condition precedent isn’t met or a deadline is missed, contracts are treated inconsistently between departments or an automatic rollover clause is forgotten. Your operation may rely on a vendor meeting the terms and conditions of a contract that your legal department drafted. Conversely, a vendor may sneak hidden clauses and language into their contracts.
It’s clear that many of these risks are intrinsically linked. The effects of one form of risk can create a domino effect that threatens to overwhelm your institution.
Learn more about vendor risk management…
How can you hope to put the necessary controls and procedures in place to manage the overwhelming volume of risks involved in managing vendors? A VRM software solution can help you automate your vendor management process and strengthen your VRM program.
A truly best-in-class VRM solution puts you in control, with advanced features such as vendor risk assessment, automated vendor monitoring, fourth-party vendor tracking, concentration risk analysis, and more.