Types of Vendor Risk: Learn Industry Vulnerabilities

Are you unsure which types of vendor risk could affect your organization? Outsourcing critical operations to third-party vendors saves businesses money and increases efficiency. However, there are also inherent risks involved with outsourced services. Companies must understand and manage those risks holistically by developing a comprehensive vendor management program. It’s essential to take a risk-based approach to vendor management, and it requires companies to understand the different types of vendor risk thoroughly.

This article will discuss compliance, cybersecurity, operational, reputational, strategic, and financial risks. Each section will provide a high-level overview and possible implications for your organization.

Types of Vendor Risk You Must Monitor

Vendor risk is a broad term that covers several distinct risks to your company and customers due to your outsourced vendor relationships and each vendor’s services or products. Identifying types of vendor risk for each vendor is a helpful method to determine what vendor risk mitigation might be necessary and what levels of risks are not acceptable for your organization.

Understanding the nature of vendor risks and identifying them is an essential component of effective vendor risk management, which starts with adequate regular due diligence on all your vendors.

Here are the most common critical risks to be aware of when evaluating third-party vendors:

Compliance Risk

This type of risk arises from a vendor’s failure to comply with laws and third-party risk management regulations or standards governing your company’s products and services to its customers. Vendors must comply with laws, regulations, and rules passed down by regulatory bodies that affect your company and industry. Failure to meet compliance standards can result in harsh fines, enforcement actions, and a blow to your organization’s reputation.

Cybersecurity Risk

This type of risk is one of the biggest concerns when doing business with third-party vendors due to growing cyber threats. It includes data breaches, ransomware, malware, and cyber events. Security breaches in your vendor’s systems can damage your information technology systems and disrupt your business processes.

Operational Risk

Operational risk is created by the possibility of a vendor’s action that causes an operational shutdown. The risk of loss may result from a vendor’s ineffective or failed internal processes, people, controls, or systems. When vendors cannot provide services as promised, companies usually cannot perform daily activities. You must create a business continuity plan to limit operational risk and perform periodic vendor due diligence checks.

Reputational Risk

This type of risk is concerned with the public perception of your company. Your company’s image can get ruined in the minds of consumers, the public, the media, and investors due to vendors’ actions, poor service, lawsuits, outages, fraud, or data breaches.

Strategic Risk

This arises when a vendor makes business decisions that do not align with your company’s strategic objectives. Strategic risks can influence compliance and reputational risks. They have become particularly urgent due to rapidly evolving business and market trends and technological innovations, for example, the Internet of Things (IoT) and Big Data. Establishing key risk indicators (KRIs) allows businesses to effectively monitor strategic risk because they provide valuable insight into vendor operations and processes.

Financial Risk

This is the potential negative financial impact on your organization due to a vendor relationship. Financial risk involves a vendor action damaging the financial standing of a company. The damage may come in substandard vendor work or a defective component that slows business and reduces revenue. Economic damage can also be in the form of fines or legal fees.

How To Categorize Types of Vendor Risk

Knowing types of vendor risk allows companies to accurately assess the risk posed in third-party relationships during the entire third-party risk management lifecycle and classify vendors based on the threat they pose to the business.

The first step in vendor risk categorization is using a risk-based approach to identify your critical vendors. The vendor classification will help you determine the level of your oversight activity. You need to consider the following attributes as indicators for your classification:

  • Business criticality
  • Data sensitivity
  • Regulatory impact

You must then add risk tiers according to your vendors’ risk levels. Companies generally categorize their third-party vendors as high-risk, medium-risk, or low-risk. The vendors that deal with the most business-critical operations or sensitive data are most likely to be rated medium or high-risk vendors. The vendors that don’t interact with critical systems, networks, and data are ranked low-risk.

First, You should create a vendor inventory to identify and manage high-risk vendors. You should then remove from further review the low-risk vendors without access to your data or financial transactions, for example, vendors who supply food or office equipment and supplies. Although you should create an inventory of your low-risk vendors, you typically don’t have to take any other action because these vendors have minimal impact on your company in the event of a data breach. However, you must track them on your vendor inventory list to show you have performed your due diligence.

The Start Team Will Help With Your Types of Vendor Risk

While this was only a high-level review of the many types of vendor risk that could affect your organization, the Start team has worked within countless industries providing vendor risk management strategies. Our team would love to go into further depth to understand your business and potential risk.

You can book a call with our team if you want to stay risk-averse. Click the link to book a meeting with our team!

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