Vendor Concentration Risk is the risk which may occur when an institution relies too heavily on one vendor to perform several, if not all, critical/high risk functions for their operation. Vendor concentration is common in the industry.
An example of vendor concentration risk could include a vendor who supplies the LOS, credit, income verification, appraisal and flood information. Should the vendor have a system outage, the impact could cause several delays in the overall process. Additionally, centralizing all services really requires the assurance that each product or service is staffed appropriately not only from an administrative perspective, but from a subject matter expertise level.
We mentioned this concept in a post a few weeks ago, so thought we would dive a little deeper into the pros and cons of vendors who fall into this category. Reminder, with this vendor, you need to dive deeper into the operation.
Pros & Cons of Vendor Concentration Risk
A valid point of concentrating or limiting the vendor pool may be tied to a couple of areas. Bulk pricing for placing all your eggs in one basket.
What may seem appealing at first though can usually be uncovered as a pricing strategy that offers up a loss leader on the main product and the vendor simply makes up that loss by up charging the many ancillary products to make up the difference. A savvy vendor manager or executive will look closely at this and know what the true market pricing is on each product.
Some vendors might have talent in all the areas they offer - so it could be beneficial to take advantage of their expertise.
You should really consider expertise and service levels. As vendors jump on the latest product craze there is risk that you’ve engaged with a wannabee and not an expert in their field. To spot the actor in the market place, it's wise to know the products you need intimately, know what are realistic standard turn times are and who else is currently using this service.
Look at service levels. Invariably you will get what you pay for.
Be careful when it comes to chasing price. In the lending industry, the turn time and quality of the information or service should be given considerable weight in making a decision. Put simply, if Vendor A, is $2 cheaper than Vendor B, but Vendor B can deliver the service 2 days quicker...then Vendor B should win the case. Having the mindset of "time is money" is cliche, but a good rule of thumb to work with.
Less Vendors = Less Oversight
This is a valid point. If you bundle products with one vendor, then your annual assessment and due diligence would logically reduce. You may be able to realize cost savings in site visit and FTE requirements. Remember that you should always confirm that the vendor and different product or service departments are working within the same corporate policies and procedure guidelines. Where they divert, it's critical that you review any differences to ensure that you have a solid understanding of their overall operation and regulatory compliance risk.
In the OCC July 7th update, it was noted that the regulator is aware that vendor consolidation is occurring in the financial services industry and cautions that due to this consolidation there may be an increased burden on the vendor to perform.
They specifically highlight an increase in Operational Risk. Operational risk continues to challenge banks because of increasing cyber threats, reliance on concentrations in significant third party service providers and the need for sound governance over product service and delivery.
You can read the update here: https://www.occ.treas.gov/news-issuances/news-releases/2017/nr-occ-2017-78.html
Criticality and Concentration
If you bundle multiple products with 1 vendor and fail to have a reliable back up in place, you may have inadvertently elevated a high risk vendor into the critical rating, which could potentially cause significant business operation challenges in the event of an outage.
A sound vendor management and procurement strategy should be balanced and make good strategic business sense. While there is focus on the increasing costs of loan manufacturing, chasing down the spend line item may also land you in trouble if the vendor fails in terms of quality and service.
Interaction with the line of business and understanding of how third party products are used within your operation will offer more insight than simply looking to bundle and reduce vendors.
While the C-suite is rightly concerned with cost containment, few are willing to sacrifice excellent customer service. Left unguarded, a short-sighted vendor procurement strategy can leave you short of your overall goals. For this reason, it's critical that the board-level of executives clearly communicate its overall business goals and objectives. Understanding how they view vendor management is vital in how you approach your management of third party vendors.
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