Third-Party Risk Management: All You Need To Know

“Risk management is a more realistic term than safety. It implies that hazards are ever-present, that they must be identified, analyzed, evaluated, and controlled or rationally accepted.” – Jerome F. Lederer

Given the growing digital landscape, organizations rely on third-party vendors for improved profitability, decreased costs, and faster time to market.

However, third-party vendor relationships come with multiple risks. In fact, 44% of companies have experienced a significant data breach through a third-party vendor. This makes it crucial for you to have a risk management policy in place.

In this blog post, we dig deeper on the concept of vendor or third-party risk management (TPRM), its types, as well as its stages.

So, let’s get started!

What is Third-party Risk Management?

Third-party risk management (TPRM) is a discipline that focuses on recognizing and minimizing risks associated with third-party suppliers or vendors.

Also known as vendor-risk management, it gives organizations an understanding of how they use third parties and what security measures the third-parties have in place.

As a result, you get to learn whether a particular vendor or service provider can keep your organization’s information assets safe or not.

What Are The Types Of Third-Party Vendor Risks?

Here are six types of third-party vendor risks you need to know while evaluating third-party vendor risks –

Cybersecurity Risk

Cybersecurity risk is an outcome of cyberattacks or data breaches, and increased cyber threats calls for strict monitoring of your vendor’s cybersecurity posture. It includes –

1. Identifying your organization’s risk threshold to quantify vendor cybersecurity risk.
2. Assessing the third-party security performance and making the necessary adjustments.
3. Focusing on compromised systems within vendor network environments while evaluating performance.

Operational Risk

Operational risks are a result of the disruptions in business operations due to a third-party vendor. Usually such disarrangement is managed through service level agreements (SLAs).

Organizations dependent on third-party vendors for performing their daily operations can encounter such risks when vendors are unable to deliver.

In such scenarios, they can opt for a backup vendor to ensure business continuity, which can help limit operational risks.

Compliance Risk

Compliance or legal risks occur when a third-party vendor affects your business compliance with local regulation or agreements. This applies particularly to financial services, government organizations, and healthcare services.

Although the organizational laws may vary depending upon the industry, there are some regulations such as GDPR and PCI DSS, which are commonly followed across industries.

Non-compliance with these regulations can result in heavy penalties. Therefore, it is vital to ensure that your third-party vendor’s cybersecurity compliance is aligned with the mandatory regulations.

Reputational Risk

Reputational risk is associated with:

1. Negative public opinions about an organization because of a third-party vendor.
2. Events like dissatisfied customers, poor reviews, third-party breaches due to poor security controls.
3. Scenarios such as disclosure of customer information due to negligence, violation of laws, inconsistent interactions with company standards.

Such risks can arise without any prior warning, hence posing a threat to the survival of a business.

Financial Risk

There are two main types of financial risks related to third-party vendors –
1. Excessive costs
2. Lost revenue

When vendors are unable to complete the fiscal requirements set by your organization, your business can face a financial risk.

You can limit excessive costs by conducting periodic audits to check if the vendor is spending in line with the contractual obligations.

Identify the vendors that directly impact your organization’s revenue generation in order to manage lost revenue.

Strategic Risk

These kinds of risks occur when the vendors making business decisions do not align with the organization’s strategic business objectives. Such risks can influence compliance and reputational risks, hence impacting the organization as a whole.

Measure KPIs to effectively monitor strategic risks as they can give you a detailed insight into the vendor processes.

What Are The Stages Involved In Third-party Risk Management?

Stage 1 – Vendor Identification

The first stage under third-party risk management is vendor identification. It is the process of identifying new service providers or existing vendors that might pose a risk.

To identify the existing vendors and build a vendor inventory, organizations take approaches such as:

a. Consolidating vendor information from different sources while developing a third-party risk
software.
b. Integrating detailed vendor information with existing technologies to devise a centralized software
solution.
c. Conducting assessments across the organization to keep a check on the tools in use.

Stage 2 – Evaluation and Selection

During this stage, organizations consider Request for Proposals (RFPs) and select a vendor that meets their requirements.

Along with RFPs, it also includes a number of other factors such as comparing the vendor to competitors and completing a risk assessment and other diligence requirements.

Stage 3 – Risk and Due Diligence

A vendor risk management program can be as strong as the due diligence process implemented at an organization. It should be done on a periodic basis and critical vendors should be re-evaluated at least annually.

All the documents received during the due diligence process should be analyzed closely as part of your vendor risk management. A periodic due diligence process, if done correctly includes:

a. Reviewing the vendor’s financial statements as and when they are released.
b. Continuing to evaluate the vendor’s SOC reports. Faulty security controls can impact your organization.
c. Completing annual assessments in areas like risk, performance, information security, etc.

Stage 4 – Risk Mitigation

Once the assessment is complete and risks are identified, the risk mitigation process should start. These are some common risk mitigation workflows:

a. Risk flagging and score designation
b. Risk evaluation against the risk appetite definition of your organization
c. Treatment and control validation in the scope of your desired residual risk level.
d. Repeated monitoring for increased risk levels

Stage 5 – Procurement (Contracting)

From a third-party risk point of view, the contracting and procurement process is pretty crucial. This is sometimes done in parallel with risk mitigation.

Procurement should save the organization from third-party risks by negotiating contractual agreements that protect the strategic objectives of a business and prevent legal risk.

Third-party vendor risk management teams should look for key provisions, clauses, etc while reviewing the third-party contracts. Some of these terms/clauses might include:

a. Defined scope of products/services
b. Price terms
c. Intellectual property ownership clause
d. Confidentiality clause
e. Warranties

Stage 6 – Onboarding

Vendor onboarding is the process of collecting information and completing the documentation to approve a vendor. This process usually takes place along with procurement but it can also involve people representing accounts, finance, and supplier departments.

The major aim of onboarding is to centralize vendor data so that it is accessible to key stakeholders. The next step should be to define vendor profiling and setting up a criteria to categorize vendors. Now, calculate the inherent risks associated with new vendors to leverage your Vendor Risk Management (VRM) solution.

Stage 7: Ongoing Monitoring

This phase involves continuous monitoring of the third-party relationship with the organization. Here are the activities done within an organization to assess the third-party relationship:

1. Issue Reporting And Resolution – Analyzes issues arising in third-party relationships. Issues might be reported by employees, management, third party, and customer complaints.

2. Performance Monitoring – Maintains and monitors the health of the relationship between a third-party and an organization, the value it is providing, and the satisfaction level of SLAs.

3. Risk Monitoring – Identifies potential risks concerning the third-party relationship throughout the lifecycle.

4. Compliance Monitoring – Examines relationships in a way that they are in conformity with compliance requirements.

5. Audits – Exercises control over auditing clauses and doing onsite inspections of third-party premises.

Stage 8 – Vendor Offboarding

A thorough offboarding process is crucial for security purposes. Organizations usually develop a detailed checklist for offboarding vendors that aligns with recordkeeping requirements.

This checklist can include an internal and external assessment, which can confirm that appropriate controls were in place throughout the lifecycle.

This stage is critical as it requires you to maintain a detailed evidence trail of activities that exhibits compliance in the event of a regulatory audit.

Key Takeaway

Outsourcing is a vital component that efficiently drives most businesses today. It can save costs if you don’t have organizational expertise.

But at the same time, it leaves your business at the hands of a third-party vendor and can make your organization vulnerable. Therefore, a thorough process for managing risks should be followed.

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