Published on: May 12, 2022
Understanding the Foundations and Benefits of Vendor Risk Management
Outsourcing has become a popular business strategy to help organizations save money and optimize operational efficiency. However, since vendors often have access to critical systems and data, using third parties introduces risks that can lead to severe damage to your organization if not properly managed.
Here is where Vendor Risk Management (VRM) comes in.
This article will help you understand everything about the foundations of VRM, from key definitions, types of risks your organization might be facing, how to manage the vendor ecosystem to the benefits of an effective VRM.
Traditional vs. Enterprise Risk Management
A good idea would be to define these two popular concepts. Traditional Risk Management (TRM) is defined as an organization's earliest form of risk management that addresses loss exposures generated by financial, operational, and credit risks. It is a reactive approach that seeks solutions when problems surface.
However, this siloed approach and its limited scope on financial hazards make it challenging for organizations to proactively anticipate new risks and make informed decisions at the strategic organizational level.
On the other hand, Enterprise Risk Management is a more holistic and strategic evolutionary approach to risk management. It's a program developed by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in 2004, that aims to anticipate potential opportunities and threats affecting an organization and make decisions at the top management level.
It also encompasses a broader range of potential risks, including strategic, business, operational, financial, reputational, and regulatory risks. ERM integrates risk management principles with business strategy to drive performance more effectively.
Vendor Risk Management is a critical component of ERM, allowing organizations to identify and mitigate risks associated with their vendors and third-party service providers.
The main reasons why Vendor Risk Management is vital include the following:
Emerging privacy regulations that make data controllers and processors responsible for the entire data flow.
Infosec standards that mandate vendor assessment.
Interconnected systems (DevOps, infrastructure).
Resilience becoming a hot topic.
Vendor Risk Management helps organizations ensure that their vendors are adhering to the same data protection and security standards as the organization itself, thus reducing the risk of data breaches and other security incidents.
Third-Party Risk, Vendor Risk, Supplier Risk, Service Provider Risk - What's the Difference?
Organizations may use different terminology in vendor risk management to describe their vendors. Using vendors interchangeably with other terms such as third party, supplier, or service provider can get confusing as these terms look all the same from a quick glance. However, there are subtle differences between these terms.
Before diving into the differences, let's start with where they are the same. Third-Party Risk Management (TPRM), Vendor Risk Management (VRM), and Supplier Risk Management (SRM) are programs that organizations employ to manage their relationships and risks associated with external parties. The purpose of the programs is the same " identify, assess, manage, and mitigate risks concerning external parties.
Now, let's check out the differences. Slight variations arise in the nature of the relationship and resources provided by them.
Third-Party Risk Management (TPRM) is a generic catch-all term used to describe the management of risks from all third parties with which an organization interacts or does business with. This would include various external parties which fall into different categories, such as business partners, service providers, suppliers, vendors, customers, even government agencies, and not-for-profit entities, to name a few.
In essence, TPRM is the overarching umbrella that covers all types of risk management activities associated with each external party with which the organization has a business relationship.
In contrast, Vendor Risk Management (VRM), Supplier Risk Management (SRM), and Supplier Provider Risk Management are narrower in scope and used to describe the risk activities associated with a service or product provider.
Supplier Risk Management (SRM) focuses on a vendor's processes, policies, and financial health to determine their risk level and supply chain workflow.
Understanding Third-Party Cyber Risk
Among the many forms of risk introduced by external partners, third-party cyber risk stands out as particularly dynamic and, at times, unpredictable. Unlike financial health or compliance checks, which can often be reviewed at set intervals and remain fairly stable, cyber risk can shift in real time. An organization might feel confident after conducting a one-time vendor security assessment, but the cyber threat landscape can change overnight. A vendor with a clean bill of health today could become a liability tomorrow.
The unique challenge with third-party cyber risk lies in its ability to cause immediate and widespread damage. Data breaches, ransomware attacks, and operational disruptions have the potential to ripple out, affecting not only your organization’s systems but also customer trust, regulatory standing, and bottom line. The interconnected nature of today’s business services, think integrated SaaS providers, cloud platforms, or software development teams, all broaden the attack surface.
Unlike other vendor risks, ongoing vigilance is essential. Where you might check a supplier’s solvency annually, monitoring for cyber threats requires continuous attention. Tools such as security ratings, vulnerability scans, and automated alerts help organizations keep tabs on their vendors’ security posture as it evolves.
It’s also important to recognize that third-party risk extends beyond direct partners. If your vendor relies on their own external providers (commonly known as fourth parties), hidden vulnerabilities can lurk further down the chain. Incidents at this level. Say, if a data center provider used by your cloud vendor experiences a breach, this can have knock-on effects leading back to your organization.
Ultimately, third-party cyber risk is unique because it is ever-present, rapidly evolving, and capable of triggering significant organizational fallout with little warning. Diligent and ongoing cyber risk management, both for direct vendors and their suppliers, is essential to maintaining resilience in this interconnected environment.
What's the Big Deal About Vendor Risk Management?
In recent years, outsourcing has become a necessary business component in a highly connected world. Engaging third-party subject matter experts to provide these services can lead to cost savings, a wealth of expertise not currently available in-house, and stronger performance results.
A company can launch, expand or scale its business quickly without requiring a massive investment to build the infrastructure from the ground up. Whether hiring contractors or launching a new solution or technology, many vendors can support these initiatives.
On the flip side, the vendor relationship also presents more significant risk and uncertainty to the organization. There is a dependency on the vendors to provide a crucial function, both reliably and consistently.
Unfortunately, any service disruptions to the vendor's operations can lead to a domino effect that can potentially affect millions of businesses or customers.
Recent global events such as the COVID-19 pandemic, supply chain blockage of the Suez Canal, rising energy prices from the Ukraine-Russia war, or cybersecurity attacks on international vendors (such as Colonial Pipeline, JBS Foods, Kaseya and SolarWinds) have amplified the crippling effects of vendor disruptions. No business is immune, regardless of the organization's size, industry, or geographic location.
Implementing an effective vendor risk management (VRM) program can minimize the harmful impacts of these events and reduce an organization's overall risk exposure from third-party services.
More importantly, Vendor Risk Management has also become a legal requirement. For example, the GDPR requires organizations to conduct risk assessments to identify internal risks and with third parties that will manage personal data.
The Risks Vendors can Introduce Into Your Organization
Vendors are an extension of your business, which means an organization is ultimately liable for consequences resulting from business failures, service disruptions, or security breaches.
Having a thorough understanding of the different types of vendor risks will help you to classify vendors based on their potential threat to the business and minimize the magnitude of reputational damage from adverse events.
When designing a VRM program, the question arises as to what aspects of the vendor relationship to focus on. Since assessing every risk is unrealistic, taking a risk-based approach and focusing your attention on common vendor risks is a good starting point.
The following are some of the top risks that are important for you to monitor:
Compliance and regulatory risk: A vendor violates laws or regulations that you're obligated to follow. Depending on your industry and the services offered, the business may be required to comply with privacy, data protection, financial or environmental regulations. A failure to maintain compliance can result in harsh fines and enforcement actions against the business.
Cybersecurity risk: Vendors may be susceptible to data breaches, malware, ransomware, and other cyber-attacks. The increasing sophistication and volume of cyber threats on vendors make monitoring a vendor's cybersecurity posture more critical than ever.
Financial risk: Your organization could miss its financial performance goals when a vendor fails to deliver on requirements or high vendor costs are not adequately addressed.
Operational risk: A vendor's failure to deliver the services or goods as promised could lead to the organization's inability to carry out subsequent activities. Resilience is essential to operational risk management because it ensures that an organization can continue to deliver critical operations despite disruptions.
Reputational risk: Your organization's public perception and brand could be jeopardized if the vendor you're doing business with is operating in a manner that is inconsistent with the organization's core values or standards.
Strategic risk: When a vendor makes business decisions that are not aligned with your organization's strategic direction, it could impede your ability to capitalize on evolving market trends and business transformation.
The bottom line?
The type of risk a vendor poses to your business will be different, depending on the nature of the business relationship and the services provided. For instance, compliance and regulatory risk will be more significant to a healthcare service provider with access to customer personal health information (PHI) than a supplier who sources office equipment for your business.
In contrast, the supplier would pose a higher likelihood of operational risks from the non-delivery of products due to supply chain disruptions.
Taking a risk-based approach is vital.
Why is this?
Because risks are inherent to every business and cannot be entirely avoided. Accurately assessing "what" risks are applicable to "which" vendors will allow the organization to make informed decisions about the vendor and implement remediation strategies to reduce vendor risks to an acceptable level.
Potential Consequences of a Vendor Cybersecurity Incident
A cybersecurity incident stemming from a vendor relationship can have far-reaching and sometimes irreversible impacts on your organization. Unlike other risks that might surface gradually, cyber threats can materialize in an instant, leaving little time to react.
Some of the most critical consequences include:
Unauthorized Access to Systems and Data: Vendors often require access to sensitive systems and data to perform their roles. If their security measures fail, attackers may gain a direct channel into your network, putting your confidential information and intellectual property at risk.
Operational Disruption: A cyber incident can halt core business functions, either by locking down systems, corrupting essential data, or disrupting services. This downtime can translate into lost productivity, missed opportunities, and dissatisfied customers.
Financial Repercussions: Breaches can result in substantial financial losses, from direct theft or fraud to the costs associated with investigating, containing, and recovering from an attack. Legal expenses, regulatory fines, and compensation to affected parties can quickly add up.
Reputational Damage: News of a vendor-related breach can erode customer trust, attract negative media attention, and harm relationships with business partners. In some cases, reputational damage may linger long after technical issues are resolved.
Legal and Regulatory Liability: If a vendor's cyber lapse leads to a data breach or non-compliance with regulations like GDPR or HIPAA your organization could face lawsuits, governmental investigations, and steep penalties.
Because these impacts can ripple through every corner of your business, it's crucial to monitor vendor cybersecurity posture continuously, not just during annual audits or assessments.
What Is Fourth-Party Risk Management and Why Does It Matter?
While it's essential to monitor the risks posed by your own vendors, it's equally important to recognize that your vendors rely on their own network of suppliers and service providers. Fourth-party risk management is the process of identifying, assessing, and mitigating risks that originate from these external parties—your vendors' vendors.
Why should organizations care? Because a vulnerability or security lapse in a fourth party can indirectly impact your business, even if you don't have a direct contract with them. For example, if your cloud hosting provider uses a third-party data processor that suffers a breach, your data and operations could still be exposed. As businesses become more interconnected. Think about global supply chains, cloud infrastructure, and Managed Service Providers, it's critical to understand the full ecosystem of risk.
Incorporating fourth-party risk management into your vendor risk program allows organizations to:
Map out indirect dependencies and critical paths in the supply chain.
Gain better visibility into where sensitive data may flow beyond primary vendors.
Ensure higher levels of due diligence and resilience planning.
Respond proactively to emerging regulatory requirements that increasingly demand transparency in these extended relationships.
By considering both direct and indirect risks, organizations can strengthen their overall risk posture and avoid surprises lurking deep within their vendor landscape.
Benefits of an Effective Vendor Risk Management Program
Implementing a VRM program will help effectively manage the sheer volume of vendors and associated risks systematically and transparently. With a robust VRM program, you will control every aspect of the vendor relationship. The program will provide valuable insights to simplify and scale your risk management process. Even though there is no one-size-fits-all approach, key benefits include the following:
Enhance day-to-day operational efficiencies by streamlining and automating key functionalities.
Minimize adverse business disruptions by mitigating critical vendor risks before they become a threat.
Enforce accountability by monitoring performance against contractual obligations.
Control costs by identifying vendor redundancies and addressing overspending.
Monitor vendor adherence to industry standards or regulations.
Who Should be Assessing Their Vendors and When?
Any organization that uses vendors will benefit from implementing a VRM program. Vendor assessments can take place during any stage of the lifecycle - from initial scoping of potential vendors to continuous monitoring activities of existing vendors.
Phase 1 (Procurement):
Every vendor, no matter its size or type of services to be provided, should be evaluated before entering into a partnership (you don't onboard a vendor anymore if they don't pass a privacy assessment).
The due diligence activities will vary depending on the vendor's criticality for the service delivery. For example, IaaS vendors are critical for any SaaS company. Critical for SaaS service delivery.
Another factor influencing the assessment rigor is the type of services being provided and the level of vendor access to your "crown jewels". A vendor with access to corporate strategies or regulated customer data (such as PII or PHI) will warrant a thorough analysis of their cybersecurity controls than a vendor who does not have access.
Phase 2 (Continuous Monitoring during Vendor Lifecycle):
This phase is an essential strategic aspect of a robust VRM program. Implementing a governance capability to track vendor performance in real-time in a dynamic environment will enable more effective decision-making and raise awareness of emerging threats.
Suppose your business runs in a regulated industry or provides service to a specific group of customers. In that case, regulators in your respective jurisdictions will have mandates to evaluate and monitor vendors throughout the lifecycle of the relationship (GDPR, HIPAA, HITRUST, CCPA).
Suppose you are a service provider operating in an unregulated sector and undergo an annual certification to validate control effectiveness. In that case, there is a requirement to assess potential new vendors and evaluate the performance of existing vendors on a yearly basis (SOC 2, ISO27001).
Managing the Vendor Ecosystem
To ensure that vendors are performing following standards and regulatory requirements, organizations have several resources available to manage the vendor ecosystem. The following are some common practices and guidelines that serve a critical role in VRM:
Pre-contractual diligence: Request for Information (RFI), Request for Proposal (RFP), or Request for Quote (RFQ) are used to obtain information about the vendor's goods and services during the procurement process.
Vendor contract management: Manage vendor contracts and legal aspects of the relationship. Data Processing Agreements are usually annexed to the service agreement, and they dictate the rules to subprocess confidential data.
Performance evaluation: Assess and monitor vendor performance and control effectiveness via audits, site inspections, and vendor questionnaires.
Security scorecards: Assess vendors across a benchmark of risk domains, and assign a grade ranking to signify the vendor risk level.
Frameworks and regulatory standards: Publications issued by policymakers, regulatory bodies, or accredited professional associations to guide organizations on their obligations
Organizations can perform these activities and track them manually using templates and spreadsheets.
While this approach is suitable when there are only a few vendors and minimal operational complexity to account for, the program becomes time-consuming and challenging to manage as volume increases, regulatory requirements intensify, and transactions get complex.
In recent years, technological innovations and the transition to cloud-based services have given rise to modern solutions that can help organizations transform and scale their VRM program via automation, integration, and enhanced data analytics capabilities.
These solutions, whether complete GRC platforms or VRM-specific solutions have revolutionized how we manage vendor risks in the best way possible by bringing everything together.
You can achieve this through a centralized database for vendor contract and performance tracking, consistent methodology for managing risks, simplified and automated vendor assessments, real-time and transparent reporting capabilities, and seamless integration with existing systems.
Key Takeaways
Outsourcing is a popular business strategy that can lead to cost savings and operational efficiency but also introduces risks associated with vendor relationships.
VRM is a critical component of ERM that helps organizations identify and mitigate risks associated with their vendors and third-party service providers.
Vendor Risk Management is also vital because emerging privacy regulations, infosec standards, interconnected systems, and resilience are becoming hot topics.
Implementing an effective VRM program can minimize the harmful impacts of vendor disruptions.
Manual tracking of VRM activities can become time-consuming and challenging to manage as volume increases and transactions get complex.
Technological innovations and cloud-based services have given rise to modern solutions that can help organizations transform and scale their VRM program via automation, integration, and enhanced data analytics capabilities.
