Vendor Risk Management: What is it and why does it matter?

Paras Kela

Senior Writer:

green tickReading Time: 9 Minutes
green tickPublished : September 20, 2022

Vendor risk management is one of the most important factors that organizations often miss or overlook when partnering with a third party, vendor, or service provider. Ignoring this element could cost your company a big time.

It can disrupt operations, harm your brand reputation, land you in legal trouble, blow data protection cover, prevent you from providing personalized customer service, and financially harm the organization, among other things.

To avoid all these adverse consequences, you must implement a vendor risk management (VRM) program to identify and mitigate any potential risks posed by third-party vendors or service providers. This definitive guide will discuss vendor risk management in detail to give you all the information you need.

What is Vendor Risk Management ?

Vendor risk management process

Vendor risk management (VRM), also known as third-party risk management (TPRM), is the process of identifying and mitigating the risks to an organization posed by a relationship with a specific vendor or vendors. The process entails assessing the internal perspective of that risk factor and its inherent risks. 

Once the risk factors have been identified, the company collaborates with the vendor to mitigate those risks.

The ultimate goal of vendor risk management (VRM) is to ensure that the use of third-party products or services, as well as third-party relationships, do not negatively impact or disrupt the company’s operations, financial health, supply chain, or brand reputation.

Why is Vendor Risk Management Important?

Vendor risk management or third-party risk management is important for various reasons, including protecting the organization from all the risks mentioned above. In other words, third-party risk management is critical for every organization because it shields them from the risks associated with their partnerships with third-party companies or service providers, as well as helps them achieve a complete business transformation.

third party vendor risk management statsIf a company joins forces with third parties without first completing a vendor risk management program, there is a good chance that they will face some difficulties in the future due to the third-party product or service, which can impact your operations, security, or reputation as well.

Let’s look at an example to better understand this.

Assume you’ve installed a free SaaS spend management tool to detect duplicate apps, remove unnecessary apps from the portfolio, and reduce SaaS spending. And, in order to attain the best results, you shared your data with the SaaS portfolio management service provider.

Unfortunately, hackers gained access to that supplier’s system and stole data, including yours. This will definitely have an impact on your operations and reputation.

In a nutshell, a third party risk management program is necessary to safeguard your organization from any mess-ups or breakdowns at third parties or vendors.

What is the difference between A Vendor, Third Party, Supplier and Service Provider?

Although all of these terms may appear and sound identical to you, they are technically different from each other. Let’s take a look at what each of them means.

A. Vendor

A vendor is an individual or a company that buys or sells goods to another individual or a company, usually in exchange for money.

B. Third Party

A third party is an individual or entity involved in a service or product transaction but is not one of the principals and has a lesser interest.

Vendors vs Suppliers

C. Supplier

A supplier is a person or entity who sells goods to another person or organization. Typically the suppliers are manufacturers or distributors who supply goods or services to vendors, who then sell them in exchange for money.

D. Service Provider

A service provider is an individual or entity that provides services to other parties, such as consulting, legal, real estate, information technology, communications, storage, and processing.

6 Types of Vendor Risk Management

A vendor risk management program typically involves six risk categories: cybersecurity risk, compliance risk, reputational risk, financial risk, operational risk, and strategic risk. Let’s take a quick look at each one.

1. Cyber-security risk

Cyber-security risk analysis identifies vulnerabilities in a vendor’s IT system, server, or database. This task is carried out by the vendor risk management team, who monitors and scans the vendor’s system for any signs of cyber risks, such as credential leakage, email security, domain name abuse, dark web monitoring, infrastructure damage, or protocol security.

 2. Compliance risk

Another major risk category in the vendor risk management program is compliance risk. In this process, the team performs the third-party compliance assessment both when the contract is signed and as it matures. Again, there are various types of compliances, such as data sharing compliance, federal compliance, and international compliance.

 Different types of vendor risks

3. Reputational risk

A reputational risk is a threat to an organization’s, entity’s, or individual’s positive reputation or standing. The cause of reputational risk can range from a data breach at the vendor’s organization to gross misconduct by their errant employees, a flawed product launch, and so on.

4. Financial risk:

A part of vendor risk management– financial risk analysis seeks to determine whether the vendor is financially healthy or not. Or is there any chance of the vendor going bankrupt or experiencing other financial difficulties in the near future?

5. Operational risk:

The operational risk analysis intends to evaluate the vendor’s functional capabilities for the foreseeable future. During the vendor risk assessments, the team identifies fourth parties and other companies that are critical to the success of your third party. It is determined whether the failure of a fourth party will have an impact on you in addition to the third party.

Operational risk management)

6. Strategic risk

Strategic risk is the sixth major risk analysis performed as part of vendor risk management. It determines whether or not third-party internal or external strategic decisions will have an impact on your business. It is possible that some strategic decisions made by the vendor may not align with the objectives of your organization.

It should be noted that the importance assigned to each risk analysis during the vendor risk management program differed from organization to organization. For example, some organizations are more concerned about reputational risk, while others are worried about cyber-security risk.

What are the 3 Phases of Vendor Risk Management Lifecycle?

The vendor risk management lifecycle is a series of seven processes that are divided into three phases: pre-contract, contract, and post-contract.

Vendor risk management life cycle

A. Pre-contract Phase

The pre-contract phase is divided into two processes: vendor identification and vendor qualification.

Vendor Identification and Contract

Vendor risk management begins with vendor identification. At this stage, the buyer or interested party issues a request for quotation (RFQ) for a specific service or product to vendors who are interested in supplying the specified service or product.

Vendor Evaluation

The buyer shortlists suitable vendors qualified through due diligence from the proposals received, and those vendors provide additional confidential information for confirmation by the buyer. The information includes costs, past performance records, reputation, infrastructure, compliance history, and more.

B. Contract Phase

The contract phase of the vendor management life cycle is divided into four processes: vendor onboarding, vendor performance, vendor risk management, and vendor relationship.

Vendor Onboarding

After passing due diligence, service providers or third parties are moved to the onboarding phase. This process aims to gather as much information about the vendor as possible to plan an accurate and error-free contract.

Vendor Performance

The next process in the vendor risk management lifecycle is vendor performance. The data collected during the onboarding process is used for contract management. The same data is also used to monitor and analyze vendor performance and compliance throughout their contract term.

Vendor Risk Management

All third parties pose different levels and types of risks. The risk factor varies according to the severity of the threat to your business. The team continuously monitors vendors’ key performance indicators (KPIs) in order to respond quickly to any unexpected malfunction or data exposure at the third-party end.

Vendor Relationship

During the vendor risk management lifecycle phase, both the vendor and the business work together to define the relationships and boundaries between them. They collaborate to identify and capitalize on opportunities they might not have discovered otherwise.

C. Post-Contract Phase

Post-contract is the third phase of the vendor risk management lifecycle, which includes one process known as vendor offboarding.

Vendor De-boarding

Vendor offboarding is the process of ending a professional relationship with risky vendors after the contract expires. If the vendor is small, the offboarding process is straightforward. However, in the case of large vendors, the offboarding process is quite complex and may take a while to complete.

7 Steps to Implement A Vendor Risk Management Program

steps to implement vendor risk management planEvery third party risk management program is implemented differently based on the company type, the program’s goal, and the risks that need to be analyzed. However, the most common processes or steps of the third party risk management program are as follows:

1. Identify third-party risks

The vendor risk management program begins with a thorough identification of third-party risks. This process should include an examination of all risk factors that may have an impact on your company’s operations, reputation, employee productivity, supply chain, or data security. In other words, this process aims to determine the scope of your risk management program and the risks that should be monitored.

2. Define the risk management program process

The next step of the vendor risk management plan is to define the process. Based on the analysis and understanding of its risk appetite for vendor risk, you should develop a risk framework with a coherent and consistent set of policies and procedures. This framework should also define the risk assessment model and its objective, which is critical in creating a risk profile for third parties.

3. Store data into an integrated solution

The third step in implementing a vendor risk management program is to consolidate all data about third parties and contracts into a single repository to create an integrated database. The data should be centered on third-party adherence to major compliances.

4. Continue gathering data

Data gathering processThe next step in implementing a third party risk management program is to continue collecting information about third parties’ performance. This process aims to keep yourself fully informed about the compliance practices of the third parties or vendors whose services or products you use since any compliance failure will unquestionably impact your business too.

5. Risk assessment

The vendor risk assessment process is performed based on the available data. At this point, all of the vendors’ or third-party companies’ vulnerabilities or limitations that may affect your business are identified and shared with the respective vendors.

For example, if your data is extremely sensitive, but the vendor’s database or server lacks the necessary security, the same information is communicated to the vendor, and the issue is resolved.

6. Monitor and track performance

The sixth step in the process is to monitor and track the performance. Once you have the necessary data about third-party vendors, your job is to monitor and analyze vendor compliance and performance. This process also entails reviewing third-party policies and procedures, on-site reviews, and key risk and performance indicators.

7. Take contingency measures for business continuity

This is the final stage of vendor risk management program implementation. At this stage, a contingency plan (or plan B) is developed, which is to be implemented if plan A fails. A business continuity plan aims to safeguard your enterprise from any accident or failure caused by a third party and to keep your operation running smoothly.

These are the seven steps for implementing a third party management program. Now, let’s take a quick look at best practices for vendor risk management.

What are the Best Practices of Vendor Risk Management? 

Follow the vendor risk management best practices listed below for flawless program implementation and optimum results.

Vendor risk management best practices

1. Effective communication with third parties

Establishing a solid communication channel with vendors is a critical best practice for vendor risk management. Effectively communicate your requirements and expectations to third parties. Remember that effective communication may help establish healthy relationships with vendors, whereas poor communication can work quite in the opposite direction.

2. Practice KPI-based monitoring

To better understand the vendors’ performance, you must use KPI-based monitoring. First, define your company’s acceptable or expected performance levels. Following that, monitor and analyze each vendor’s compliance with them. This technique will help you identify and retain the best vendors while reducing risks.

3. Automate vendor risk management

The third vendor risk management best practice is to replace spreadsheets with automation for the vendor risk assessment process. Spreadsheet-based evaluation is not only time-consuming, but it is also a redundant task that more often leads to errors and risks.

4. Continuous monitoring

Performance monitoringInstead of conducting periodic third party risk assessments, we recommend that you conduct continuous risk assessments. Of course, a monthly or quarterly evaluation is necessary to comprehend the vendor’s adherence to your requirements.

However, you must understand that a lot can happen to a vendor between two assessments! This is why, rather than conducting periodic vendor assessments, you should prefer continuous vendor assessments.

This brings us to the end of this comprehensive guide to vendor risk management. We are confident that you now have a thorough understanding of what is vendor risk management, its types, the vendor risk management lifecycle, steps to implement a vendor risk management program, and best practices to follow.

Frequently Asked Questions

You need vendor risk management to reduce the possibility and severity of data breaches, system breakdowns, data leaks, operation failures, reputational damage, and cyber attacks involving third parties.

The vendor risk manager's job is to ensure that they have an up-to-date and thorough knowledge of how well third parties adhere to their requirements. If there is any risk or concerning action, it is the vendor risk manager's responsibility to communicate it to vendors and fix it as soon as possible before any damage occurs.

Typically, senior management or the board of directors is in charge of vendor risk management. However, some businesses also hire a dedicated vendor risk manager to perform this duty.

A vendor risk management software system identifies, monitors, and mitigates risks associated with dealing with vendors, service providers, or third parties.

Some of the best vendor management software include Oracle NetSuite ERP, TYASuite Vendor Management, mjPRO, TallyPrime, and Gatekeeper.

Vendor security risk management is a strategy or process that ensures that any malfunction or setback at the vendor's end does not negatively impact your business's operations, reputation, data security, or performance.

Updated : March 16, 2023

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