The term "vendor risk" covers a wide range of risks your organization and its customers face due to outsourced relationships with vendors and the products or services they provide. Understanding the nature of these risks and identifying them is an essential component of effective vendor risk management.
This blog will review several types of risks, both common and lesser-known, that your organization should monitor, as well as four basic approaches for handling these risks.
10 Common Types of Vendor Risks
The following risks are typically what your organization will see when dealing with vendors:
What it is: The risk that 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.
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.
Business continuity risk
What it is: This is a risk that occurs when an outside event negatively impacts a 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.
Compliance and regulatory risk
What it is: This risk arises from a third-party vendor's failure to comply with laws and regulations governing the products and services 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.
Information security risk
What it is: This risk stems 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: Vendors may pose this risk if they process, transmit, or store your organization's or your customers' 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.
Financial and credit risk
What it is: This risk 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.
What it is: This risk covers a variety of ways in which 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. Let's say your vendor manages customer service information through a call center, and an 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:
What it is: This risk is closely related to business continuity risk. It usually occurs when one vendor provides too many high-risk or critical services or when only one vendor in the marketplace provides 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 risks 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, such as a hurricane, occurs.
What it is: This risk can occur when your vendor is located in a country or region vulnerable to 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: Potent political unrest may develop in a region where your vendor is located, causing them to be unable to sustain operations. As a result, the vendor faces a risk of business continuity due to the country's unstable government.
What it is: These risks occur when vendors violate environmental laws, treat people unfairly, or display 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
Identifying risks is the first step, followed by determining how to handle them. There are four basic risk handling techniques:
- Avoid: Don't perform the activity that presents the risk.
- Mitigate: Identity, implement and test controls that can effectively reduce the risk's occurrence, likelihood or severity.
- Transfer: You can transfer the financial impact of the risk through insurance policies or indemnification language in your contract.
- 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 monitoring the vendor and reviewing their risk levels and types periodically is essential.