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10 Types of Vendor Risks to Monitor

5 min read
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Vendor risk is a broad term covering several distinct types of risks to your organization and its customers due to your outsourced vendor relationships and the products or services provided. Understanding the nature of these risks and identifying them is an essential component of effective vendor risk management.

In this blog, we’ll review some common and lesser-known vendor risks that your organization should be monitoring and the four primary techniques to handle them.

10 Common Types of Vendor Risks

common vendor risk types

The following risks are typically what your organization will see when dealing with vendors:

  1. Strategic risk
    What it is: Occurs when a prospective or current vendor's decisions and actions are incompatible with your organization's strategic objectives.

    Examples: The vendor is reluctant to invest time, money or other resources to ensure they can provide your process, product or service within budget, on time and with sufficient quality.
  2. Operational risk
    What it is: The risk of loss resulting from a vendor's ineffective or failed internal processes, people, controls or systems.

    Examples: The vendor fails to resolve issues promptly, doesn't monitor quality or address quality failures or doesn't sufficiently train employees.
  3. Business continuity risk
    What it is: A risk that is sometimes considered a subset of operational risk and occurs when an outside event affects your third-party vendor's ability to conduct business and impacts your organization as a result. Business continuity risk can occur when a vendor fails to test business continuity and disaster recovery plans and is unprepared for technology outages and failures.

    Examples: Natural disasters, severe weather events, fires, utility outages, civil unrest, cyberattacks, pandemics, military actions or acts of terrorism can all affect the vendor’s abilities to perform business activities.
  4. Compliance and regulatory risk
    What it is: Arise from a third-party vendor's failure to comply with laws and regulations governing the products and services your organization provides to its customers.

    Examples: The vendor operates in a way that’s inconsistent with your organization's policies, procedures and standards. Additionally, the vendor participates in, or encourages, deceptive marketing practices and violates laws protecting consumer rights.
  5. Information security risk
    What it is: Stemming from third-party vendor security vulnerabilities, two of the most common cyber risks resulting from missing or ineffective controls are cyberattacks and data breaches.

    Examples: This risk can arise if the vendor processes, transmits or stores your organization’s or customer’s data. Your organization also faces risk if the vendor utilizes sensitive information in an unauthorized manner or doesn’t have third-party audits or certifications to evaluate their controls.
  6. Financial and credit risk
    What it is: Directly relates to the financial condition of the third party itself and its inability to meet their contractual obligations and provide products and services to your organization.

    Examples: The vendor has decreasing revenue due to canceled orders, loss of a major customer, more liabilities than assets or a poor credit rating. Other examples might include insufficient investor funding, cash, or credit available to meet their contractual obligations.
  7. Reputation risk
    What it is: Encompasses any of the numerous ways your third-party vendor could directly or indirectly damage your reputation, brand or name.

    Examples: This harm could result from their actions, poor service, lawsuits, outages, fraud or data breaches. Your reputation could also be damaged if a third-party vendor misrepresents their relationship with you directly or through the use of your logos or company name.

Keep in mind that risks can overlap in one or more categories. Suppose your vendor handles customer service information through a call center, and due to poor operations practices, a vendor employee uses customer information to commit fraud. That mishandling of data represents compliance and regulatory, operational, information security and reputational risks.

3 Lesser Known Vendor Risk Types

There are other risk categories that you might consider as you identify and assess vendor risk. While lesser known, they’re just as important to consider. Similar to the more common risks types, there is often overlap. These other types of risks include:

  1. Concentration risk
    What it is: Closely related to business continuity risk, it usually occurs when your vendor has too many high-risk or critical services provided by a single vendor, or there is only one vendor in the marketplace to provide critical products and services. This is also known as a single point of failure risk. Another definition of concentration risk is when a significant portion of your vendors’ subcontractors are located in the same geographic area. The close proximity of vendors could cause additional business continuity risk if there were a natural disaster or another external event.

    Example: A vendor’s critical subcontractors (your fourth parties) are all located in the same geographic area, which is prone to natural disasters. Since your vendor can’t operate without these critical vendors, they can’t continue to provide their services to your organization if a severe weather event occurs.
  2. Geo-political risk
    What it is: Can occur when your vendor is located in a country or region that’s vulnerable to issues like political unrest, corruption or human rights violations. The vendor’s location could also be at risk of lax privacy and information security laws or other situations that could be harmful.

    Example: Political unrest could potentially build up in a region where your vendor is located, leading to an inability to sustain operations. If this occurs, the vendor is exposed to business continuity risk because of the nation's unstable government.
  3. ESG (environmental, social and governance) risks
    What it is: Present when vendors don't adhere to the laws or your organization's policies regarding the treatment of the earth and its resources, the treatment of people and human rights or have poor corporate governance and behavior.

    Example: The vendor fails to identify and adequately prevent human rights violations in its supply chains. This neglect could potentially present your organization with compliance risk.

How to Manage Vendor Risks

Once risks are identified, it’s important to decide how the risks are to be handled. There are four basic risk handling techniques:
  1. Avoid: Don't perform the activity that presents the risk.
  2. Mitigate: Identity, implement and test controls that can effectively reduce the risk's occurrence, likelihood or severity.
  3. Transfer: You can transfer the financial impact of the risk through insurance policies or indemnification language in your contract.
  4. Accept: It isn't possible to eliminate all risks. In some situations, the potential benefits outweigh the risks, and all organizations have to take on some level of risk.

In summary, identifying your vendor risks by type is a helpful method to determine what treatment of the risk might be necessary and what levels of risks are not acceptable. Remember that vendor risk profiles may change over time, so it’s essential to monitor the vendor and review their risk levels and types periodically.

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