Understanding Third-party Risk: Why It Matters and How To Manage It

April 18, 2023
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Organizations today spend a lot of time on risk mitigation and bolstering their security posture. However, a chain is only as strong as its weakest link; if you don't perform proper due diligence and choose your third-party relationships wisely, your company could be exposed to vulnerabilities.

According to one survey, 45% of all organizations experienced a third-party security incident in 2022. To help you deploy a vendor risk management strategy and protect your organization from financial loss or reputational damage, here is everything you need to know about third-party risk management.

What is third-party risk?

Third-party risks are risks that an organization is exposed to due to its partnership with a third-party vendor. Third-party vendors can be anything from an office cleaning company to your payroll processing tool. Working with a vendor that collects and stores your company's customer data is one example of third-party risk since any data breach of that vendor could put your own company's sensitive data at risk.

Since you can't control the risk management process of the vendors you work with, third-party risks are inherently more challenging to manage than internal risks. What you can do, however, is carefully evaluate the vendors you choose—and this is the cornerstone of third-party risk management.

Why identifying third-party risk is important

Today, organizations are outsourcing more of their business processes than ever before. Companies use third-party tools for recruiting new employees, running their business every day, collecting customer payments and everything in between. In fact, 60% of organizations work with more than 1,000 third parties. Utilizing the products and services of third-party vendors provides plenty of advantages, but it can also create plenty of risks. 

We've already looked at one example of third-party risk: your vendor experiencing a data breach. However, third-party cyber risk is not the only type of risk created by third-party vendors. Reputational damage, compliance risk, and supply chain disruption are just a few of the other significant third-party risks your company can be exposed to. 

To mitigate these risks and their potential impact on your business as much as possible, you have to prioritize third-party risk management.

Types of third-party risk

Most third-party risks can be bucketed into the following six categories:

Cybersecurity risk

Cyberattacks are estimated to cost organizations $10.5 trillion annually by 2025. While preventing security breaches within your organization is challenging enough, the third-party service providers you partner with can create even more potential risks to your information security. 

If a third-party vendor collects and stores any of your company's sensitive data, any cybersecurity vulnerabilities that they have become vulnerabilities for your company as well.

Operational risk

Many organizations are heavily reliant on third-party vendors for critical business operations. If those vendors suddenly go offline, it can lead to operational disruption and costly downtime. 

For example, let's say you're working with a vendor to procure a component vital to your manufacturing process. In this situation, any risk that could potentially disrupt that vendor’s supply would be a third-party operational risk. 

Another example of third-party operational risk is working with a cloud service provider (such as a payment processing service) that goes offline due to a natural disaster and leaves your company unable to serve your customers.

Financial risk

Third-party financial risk is any type of risk that could negatively impact your organization's bottom line—and almost every other type of third-party risk can potentially fall under this category. 

For example, an operational risk that hinders your company's revenue generation would cross-qualify as a financial risk. Sometimes, third-party financial risk can be as simple as a vendor unexpectedly raising prices.

Legal, regulatory, and compliance risks

In some cases, the conduct of the vendors you partner with can affect your own company's adherence to legal and regulatory requirements. This is especially true for organizations working within heavily regulated industries such as healthcare, government, and financial services.

Reputational risk

Many third-party risks can negatively impact your organization's reputation if and when they materialize. For example, a loss of business continuity due to an operational risk could cause your customers to seek products and services from your competitors. Or, a third-party cyberattack that exposes your customers' data could lead customers to view your organization as untrustworthy.

Strategic risk

Third-party strategic risk is any risk that could potentially prevent your company from achieving its goals and executing its long-term strategy. 

One example of third-party strategic risk is a change in a vendor's leadership that could negatively impact your relationship with them. Working with a vendor that a competitor acquires is another example.

How to manage and reduce third-party risk

The biggest protection against third-party risk is understanding the risks that your third-party relationships present and avoiding high-risk vendors. To achieve this, you need to implement an effective third-party risk management program.

A third-party risk management program should entail a thorough security assessment when onboarding new vendors and ongoing monitoring of the vendors you choose to do business with. With that in mind, here are the three most effective methods for assessing and monitoring third-party risk.

Third-party due diligence

When you perform third-party due diligence, you thoroughly vet potential vendors to identify any risks that partnering with them would create. 

The best way to accomplish this is by using a third-party due diligence tool like HyperComply. 

With HyperComply, you can use risk assessment questionnaire templates, automated risk assessment scheduling, security assessment workflows, and more to streamline the due diligence process. 

Along with performing due diligence when onboarding new vendors, it's necessary to routinely conduct due diligence assessments for your company's existing vendors.

Vendor security questionnaires

Vendor security questionnaires are among the most effective tools for conducting third-party due diligence. These questionnaires typically cover a broad range of topics and potential risks and are designed to provide complete transparency into a vendor's security posture. 

Common questions you will find in a vendor security questionnaire include:

  • What data does the company collect and store, and how is that data used?
  • Are there any regulatory or legal proceedings pending against the company?
  • What network access controls does the company have in place?
  • What types of disasters does the company have disaster recovery plans in place for?

Of course, this is just a small sample of the questions a security questionnaire will include. If you need help creating a comprehensive security questionnaire that includes all the questions you need answers to when vetting third-party vendors, HyperComply's security questionnaire templates are an excellent resource to leverage.

Vendor risk assessment

A vendor risk assessment is a type of vendor review designed to assess the tools, systems, and processes a vendor uses so that you can identify any risks that are present. 

Using security questionnaires is the best way to acquire this information. From there, you should assess a vendor's tools, systems, and processes against a security framework such as CAIQ Lite or SIG Lite Licensing.

Benefits of third-party risk management

Improving your company's security via effective third-party risk management is something that can offer numerous benefits, including:

Protection of company assets and reputation

The most obvious benefit of third-party risk management is that it reduces your company's risk of experiencing financial or reputational damage. From supply chain disruption that interrupts your company's flow of revenue to data breaches that leave customers unwilling to trust your company with their data, there's no shortage of ways that third-party risk can lead to loss of reputation and assets. However, effective third-party risk management reduces the likelihood of this happening.

Compliance with regulatory requirements

We've already mentioned that organizations can be accountable for their vendors' conduct if it breaches legal or regulatory requirements. Depending on the nature of your business and the regulatory requirements it's bound to, third-party risk management may be essential for maintaining compliance.

Improved operational efficiency

Along with helping you identify potential risks, the thorough vendor assessments that third-party risk management entails can also provide you with a deeper understanding of your vendors that improves operational efficiency. You can streamline vendor-related decisions by improving vendor visibility via third-party risk management. 

Better vendor relationships

Trust is the cornerstone of any relationship, including vendor relationships. By establishing the type of trust that only thorough due diligence can provide, you can improve the strength of your vendor relationships and choose vendors that will be reliable long-term partners for your company.

Minimize third-party risk seamlessly with HyperComply

Third-party risk management is a process that your organization cannot afford to overlook. Thankfully, it's also a process made much easier with the right tools—and HyperComply delivers. 

With security questionnaire templates that drastically streamline the process of creating questionnaires, HyperComply provides a variety of other tools designed to help organizations perform vendor due diligence. This includes automated risk assessment scheduling, security assessment workflows, a comprehensive vendor knowledge base, and much more.

Best of all, HyperComply is free for organizations performing vendor risk assessments. To get started using HyperComply to minimize third-party risk seamlessly, sign up for a demo today.