Vendor Risk Management (VRM) Explained

Building a Vendor Risk Management (VRM) program can feel like an overwhelming undertaking for many organizations. Here's an overview to get you started on the right foot.
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Prevalent
March 31, 2021
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Many companies are concerned about the difficulty and complexity behind building Vendor Risk Management (VRM) programs. An effective VRM program gathers all vendors in one place, classifies them, assesses the risks, provides a vendor risk score, and determines the appropriate mitigation strategies.

What is Vendor Risk Management?

Vendor risk management is the method of ensuring that the use of service providers and IT vendors does not create an unnecessary risk of business disruption or a detrimental impact on business results. VRM programs usually contain six categories of risk, including:

  • Cybersecurity risk

  • Compliance risk

  • Reputational risk

  • Financial risk

  • Operational risk

  • Strategic risk

It is important to note that depending on the type of organization establishing the VRM program, these risks may be weighted very differently depending on their impact on the organization. Different types of organizations may also have substantially different risks than the common categories listed above.

How Vendor Risk Management is Changing

Even when the expertise is there, organizations’ vendor risk management is often at the bottom of the list of competing priorities. For years, highly regulated companies such as banks and insurance companies have been required to implement vendor risk management, or "VRM," programs to meet regulatory requirements. A common traditional complaint among these organizations was that the VRM programs provided very little “business value.”

However, the landscape has changed dramatically over the last three years. Risks are substantially increasing and evolving as organizations become more interdependent in terms of networks, supply chains, data management, and operational capabilities. Business partners have moved from simply delivering contracted services to becoming cohesive parts of each other's organizations. A failure in one organization leads to business disruption in the other, resulting in legal liabilities for both parties. The changing relationships between organizations have rapidly increased VRM programs’ importance as a critical business function designed to provide leadership with early warnings of issues, challenges, and problems in their supply chains.

The increase in importance has also driven a revolution in VRM tools and programs. The lack of focus on VRM kept the processes relatively immature and lacking in either the sensitivity or speed to adequately measure and respond to vendor-posed risks. Many programs relied on tying together spreadsheet-based questionnaires with inconsistent key performance indicators (KPIs), which proved to be too slow and provided limited value. VRM risk managers have struggled to implement vendor risk management programs effectively and faced a tough fight both internally (too little perceived value) and externally (too many forms to complete). With the explosion of global supply chains, VRM tools have taken several rapid leaps forward in data collection, processing, reporting, and integration with other functions such as procurement, Governance Risk and Compliance (GRC), legal, Human Resources (HR), Information Technology (IT), and more.

The last three years have driven enormous amounts of change in the need for VRM programs’ effectiveness. The disruption of supply chains, logistics, and business workflow by COVID-19 coupled with the implementation of significant political and legal changes (e.g., Brexit and GDPR), IT interconnectivity, and outsourced critical functions and operations has created a new demand for effective Vendor Risk Management. The VRM program that enables management to identify, plan and manage risks more effectively has become a “must-have” business-critical function. This new demand is reinforced because today's risk environments are not mutually exclusive but rather interlinked. An IT infrastructure provider’s decision on the other side of the world that disrupts connectivity can derail your product delivery a month from now. In other words, vendor risk management processes must be strict enough to address a much broader perspective on threats and their impacts on organizations, and flexible enough to enable business operations. It is a delicate balancing act that is becoming an organizational imperative to companies around the world.

Vendor Management and Governance

Sometimes referred to as vendor management, vendor governance is a management strategy that enables an organization to gain value from its suppliers through cost control, value creation, and risk mitigation. When VRM is operated as a strategic business enabler, it puts your project on a firmer footing by defining the relationships and boundaries with vendors. For VRM to be effective, it is necessary to integrate VRM into the entire supplier management lifecycle, from onboarding to terminating the relationship.

VRM enables strong governance by helping organizations keep a close eye on compliance and risk management and share their requirements with the appropriate vendors. Because of the oversight requirements inherent in compliance standards, it is imperative that it is easy to follow every step of the supplier management process, from strategic discussions to outsourcing before signing the contract, to continued due diligence and monitoring. Enabling simplicity ensures that regulatory bodies, auditors, and compliance officials can quickly understand the program’s operations, outputs, and risk management efficacy. A strong supplier management program identifies and applies to all suppliers doing business with the organization.

A risk assessment for VRM is not a single step. It begins when you recognize the need for a provider and understand the importance of the services they will provide to your organization. The vendor should be classified according to standardized criteria of importance to your environment. Risk management software can make these tasks simple and automate significant portions of the repetitive tasks while providing continuous reporting on vendor performance by the service level agreements (SLAs), compliance processes (e.g., SOC 2, FEDRAMP), and reputational or operational risks, among many other functions.

Building a Vendor Risk Management Program

An effective supplier risk management program should be risk-oriented, provide oversight and controls that reflect the risks associated with third-party relationships, and provide a clear understanding of the organization's compliance requirements and the necessary regulatory controls. Suppose the customer does not require you to adhere to a specific information security framework. In that case, it is good practice to reduce your business's risk by documenting the process of risk management for sellers. Effective risk management helps identify the providers’ risks and enables organizations to react to risk and compliance problems at any time. If they follow the provider's risk management framework, they can act quickly and follow protocols in an infringement event.

The Basics of Vendor Risk Management

A positive first step in building out a VRM solution is developing an internal guide detailing how to approach third-party risk management and outlining the steps for day-to-day tasks and procedures for all internal stakeholders and process managers. It is critical to every VRM solution that the program is inclusive of everyone in the organization. It provides clear definitions, processes, and expected outcomes and deliverables for all stakeholders.

This includes finding the most suitable suppliers, obtaining price information, assessing the quality of work, managing relationships (in the case of multiple suppliers), assessing performance by setting organizational standards, and ensuring that payments are always on time. These are the types of scenarios that an organization should consider when selecting suppliers and effectively managing manufacturer risk. This could include assessing the risk that the vendor poses, assigning responsibility and accountability for managing his risk, how to draw up communication and resolution protocols for problems with the seller, how to assess each seller's performance, and how to end relationships between the seller.

At the heart of every VRM program is its ability to identify and assess risk in existing and prospective vendors rapidly. Typically the risk assessment classifies the vendors according to their risk in terms of:

  • Security

  • Compliance with standards

  • Safety

  • Reliability

  • Quality

  • Customer service

  • Costs

  • Performance

  • Availability

Once the classification is performed, it is critical to discuss with the vendor to understand plans to mitigate any identified risks that might impact their rankings.

The key benefit of a VRM program is that it enables an organization to avoid putting the organization’s welfare - its existence and financial stability - on an unstable provider of a critical service. Taking a proactive role in identifying and analyzing potential vendor partners enables you to mitigate potential risks as much as possible.

Vendor Risk Management

1: Gartner Magic Quadrant for IT Vendor Risk Management Tools, Joanne Spencer and Edward Weinstein, 24 August 2020

Vendor Risk Management Risk Assessment

In any business in the modern age of outsourcing, it is vital to develop a risk management program that takes into account the risks of third-party vendors and in many cases their extended supply chain or macro operating environment. At its most basic level, vendor risk management is the process by which an organization evaluates and manages operational, security, and financial risks from third parties and vendors. The aim of risk management for an entity is to put the organization in a sustainable position by:

  • Identifying the risk of all vendors

  • Measuring the level of risk

  • Objectively assessing each vendor

  • Mitigating those risks where it is required

  • Systematically repeating this process

The above points of the vendor management process can be achieved through a documented vendor risk management policy that would provide a framework for consistent risk evaluation, onboarding, and management of the lifecycle of vendor relationships. In addition, the process of identification, analysis, and risk management should be formally defined. In order to streamline a vendor risk assessment, the following steps are required:

  • Document the program

  • Ensure consistency when defining risks

  • Clearly define vendor requirements

  • Ensure that both the vendor’s and your organization’s business continuity are included

  • Collect data in as near real-time as possible

  • Apply the program to all new vendor relationships

  • Implement effective reporting to manage regulatory compliance

  • Mature your risk assessment of a vendor as the relationship evolves

To ensure a consistent evaluation process and risk classification, risk managers can develop a risk assessment questionnaire template for sellers that potential vendors should use.

In theory, the data collected during the risk assessment for sellers should help the organization understand the risk threshold that allows sellers and contractors to take action when these risk thresholds are exceeded. Effective risk management helps identify the providers’ risks and enables an organization to react to risk and compliance problems at any time. The seller’s risk manager should make ongoing updates to the seller’s profile to include information about the seller's financial status, business history, and other relevant information.

Vendor Management Cybersecurity

A primary driver for VRM programs is cybersecurity. Breaches from third parties are becoming more ubiquitous as technology and businesses grow. A recent Ponemon Institute study (via Security Boulevard) found that nearly half of all organizations have experienced one or more third-party data breaches. These third-party data breaches have cost an average of $7.5 million to remediate. As companies have moved to cloud offerings and fully outsourced the management of their IT infrastructure, the costs of vendor failures have continued to rise.

The Office of the Inspector General of the US Department of Homeland Security (OIG) has released a new report that analyzes the security of more than 1,000 companies in the United States and finds that companies use hundreds of providers and struggle to gain a true understanding of each other's positions on cybersecurity. The lack of established metrics and standards has led to dramatic increases in risk exposure for many organizations. Additionally, the lack of standards has also significantly complicated the remediation processes to address any identified risks.

It is key to an organization's success in managing security risk is that the following features must be present and implemented:

  • Define what constitutes a data breach

  • Define what constitutes a security incident

  • Determine the level of system/personnel access required and granted BEFORE connecting systems

  • Establish agreements by including internal and external stakeholders in procurement, legal, finance, operations, sales, IT, and cybersecurity at a minimum

  • Identify and promulgate sensitive information definitions

  • Provide standard definitions and approaches that all parties understand disaster recovery, continuity of operations, breach notification, identity and access management, incident response

By establishing standard approaches and terminology that organizations and vendors already recognize, as opposed to disparate, uncoordinated frameworks, VRM programs become much easier to implement and operate. By providing a framework for supplier risk management and compliance, your organization can act quickly and follow protocols when vendor risks rise to unacceptable levels. Conversely, the same program provides your vendor with a clear roadmap to best practices and processes that your organization can accept from a risk perspective.

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Vendor Risk Management Key Takeaways

Vendor Risk Management has become one of the latest areas where organizations must find ways and approaches to cooperate to enable the delivery of goods and services. Strong VRM solutions have the following clearly identifiable features that deliver value to both parties:

  • Clearly defined standards

  • Consistent evaluation processes

  • Standardized mitigation functions

  • Continually maturing processes

  • Engages with all vendors of the organization

  • Meets the business needs of both the organization and vendors

Implementing these features into your VRM program changes the perception from one of a “checklist-driven pain” to a valuable business function that must be included for the organization’s well-being.

Next Steps

Wondering how to get started? Check out our free best practices guide: Five Steps to Proactive Third-Party Risk Management. Want to benchmark your existing VRM practices and get a roadmap to program maturity? Request a free VRM Program Maturity Assessment. Interested in whether our VRM solutions and services may be a fit for your organization? Request a demo.

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Prevalent takes the pain out of third-party risk management (TPRM). Companies use our software and services to eliminate the security and compliance exposures that come from working with vendors, suppliers and other third parties. Our customers benefit from a flexible, hybrid approach to TPRM, working closely with each customer to tailor a solution that not only fits their unique needs, but also delivers a rapid return on investment. Regardless of where they start, we help our customers stop the pain, make informed decisions, and adapt and mature their TPRM programs over time.
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