Types of Vendor Risk
Organizations face various levels of risk from different vendors based on their position in the business, nature of service, and access to sensitive information. In this regard, the following are the essential categories of risks that any organization must assess while dealing with third-party vendors.
Operational Risk
Operational risk is the risk of a breakdown in your business process caused by your vendor. This may sometimes occur if many other reasons hamper the vendor’s performance- if the quality of service could be better, it has lost systems, or the product it promises to deliver needs to be delivered on time. For example, if a key IT infrastructure provider loses a minute, it costs your business to lose utilities or services.
Operational risk is influenced by factors like:
- The vendor cannot meet agreed contractual deliverables or binding service level agreements.
- Inadequate planning and disaster recovery of business.
- Inability to scale services to grow your business positively.
Cybersecurity Risk
As third-party vendors access your company’s data, networks, or systems from afar, the potential for cyber attacks grows. This means that, in case your partners have weak cybersecurity, they open your doors for attacks, data breaches, ransomware, or any cyber attack.
Indeed, in most high-profile data breaches, attackers gain access to the target company’s network via third-party vendors or their supply chains.
Key elements that lead to a risk in cybersecurity include:
- Poor security protocols from a vendor or no encryption.
- A lack of constant security audits and updating procedures.
- Vendor employees misuse sensitive information or systems.
Financial Risk
This happens when a vendor’s financial instability uniformly impacts the services or products they were contracted to provide. This can be most concerning when vendors form a critical link in your supply chain or business operations.
If a vendor files for bankruptcy or falls into financial trouble, this can disrupt your supply chain, slow down your operations, or even require you to replace them immediately.
Key factors contributing to financial risk:
- Vendor’s weakening financial condition or other insolvency signals
- Delays in the making of shipments hurt payments and deliveries
- Increasing expenses of substitute vendors
Reputation Risk
This is because vendors become an extension of your organization’s brand, meaning that their actions/behaviors reflect your company’s reputation. Although not directly, when a vendor is involved in unethical practices or legal offenses where, your business faces reputational damage through association. This may lead to a loss of customers and a reduction in trust, eventually translating to financial loss.
The factors that contribute significantly to this risk reputation are:
- Illegal or unethical activities by the vendor.
- Negative media concerning the vendor.
- The vendor is unable to maintain your product or service’s quality standards.
Compliance Risk
Compliance risks occur when vendors cannot uphold your organization’s legal and authorized regulations. This must be recognized, especially in industries that deal with sensitive information, such as health, finance, and specific government departments.
If non-compliance occurs, both types of fallout would involve the vendor and, secondly, your organization. These fallouts would include fines, litigation, and regulatory action.
Key factors contributing to compliance risk:
- Vendor’ not being compliant with industry-specific regulations (such as GDPR or HIPAA)
- Improper or absence of proper documentation or certification
- A Vendor’s security policy and practices could be better quality and more efficient.
Legal Risk
Contract breach and intellectual property breach disputes between an organization and the vendors it associates with can lead to expensive legal battles, fines, or penalties. These can occur when contracts must be appropriately designed and maintained.
Key factors contributing to legal risk:
- Poorly drafted contracts with ambiguously worded terms.
- Inadequate enforcement concerning confidentiality or non-compete provisions.
- Intellectual property infringement by the vendor.
Strategic Risk
This is when a vendor’s intentions or performance are in a way that hamper the ability of your organization to accomplish long-term business goals. For example, suppose a vendor cannot contribute innovations or increase the services your company requires as your company expands. In that case, your company might lose a crucial competitive position in the market.
Significant factors causing strategic risk are:
- Misalignment of vendor services with strategic objectives of your organization
- Lack of innovation by the vendor or his inability to keep pace with technological developments
- Over-reliance on a single vendor for critical services or products