The Role of Vendor Risk Management Within Your Organization

An organization’s success is built on many interrelated components. You might have one of the best products on the market, but your success will be limited without certain functions like marketing, sales, and distribution. Vendor risk management (VRM), also known as third-party risk management (TPRM), is another essential component that can contribute to an organization’s success.

Vendor risk management includes activities that identify, assess, and manage the risks associated with a vendor’s products and services. These activities aim to reduce risk, enhance the value of the vendor relationship, drive service excellence, and potentially reduce costs. One of the best ways to achieve these goals is to first understand the role of vendor risk management in your organization. 

Let’s go over some helpful concepts to clarify who and what is involved in vendor risk management.

The Role of Vendor Risk Management

So, what exactly is the role of vendor risk management? Many are surprised to learn that vendor risk management can play a key role in protecting the organization’s reputation, enhancing operational resilience, supporting contract management, and much more. Vendor risk management is ultimately responsible for ensuring the organization is engaging with its vendors in a safe and sound manner. 

This involves activities such as:

• Mitigating vendor risks such as financial, operational, cybersecurity, and compliance
• Working closely with vendors on a day-to-day basis to ensure they’re continuing to provide the expected value
• Establishing processes for vendor selection and contract negotiation
• Monitoring vendor risk continuously, even after the vendor contract is executed (e.g., monitoring performance levels and periodically requesting and analyzing due diligence documents)
• Maintaining a database of risk information pertaining to third parties and communicating this data via consistent reporting to senior leadership, relevant stakeholders, and the board
• Identifying, escalating, and remediating vendor issues before they become significant problems
• Developing exit plans for safe vendor termination
• Managing and updating processes to keep the organization in compliance with regulatory expectations

Three Lines of Defense in Vendor Risk Management

Vendor risk management is becoming increasingly important for all industries, but the practice originated in financial services where it remains highly regulated. This industry coined the term “three lines of defense” to categorize and define the overall risk management responsibilities across an organization. This concept can also be used to describe the roles and responsibilities within a vendor risk management program.

It's important to first define the roles and responsibilities in vendor risk management to limit future confusion and duplicative work. 

The three lines of defense in vendor risk management include:

• The first line of defense is responsible for managing vendor risk. Individuals who typically take on this role include vendor owners, product owners, or vendor managers. They interact with vendors on a regular basis and ensure the relationship is managed in accordance with the organization's rules and requirements. Their responsibilities include conducting inherent risk assessments, collecting necessary due diligence documents, addressing any vendor issues that arise, and managing the vendor's risk and performance.
• The second line of defense is responsible for establishing, maintaining, and overseeing the rules, requirements, tools, and processes that enable vendor risk management within an organization. This function also serves as an oversight role for the vendor risk management program. It’s carried out by individuals such as the vendor risk manager, vendor risk management team, or compliance department. The second line ensures the first line is performing vendor risk management activities correctly and on time.
• The third line of defense has the responsibility to ensure both the first line and the second line are fulfilling their respective roles and responsibilities and vendor risk management is executed effectively at the organization. The audit function lies within the third line and supervises the first and second lines. The internal audit department is a typical third-line role. These individuals perform assessments to determine whether the vendor risk management program is complying with laws and regulations. The third line will also identify any gaps in the program, so they can be presented to the board of directors and senior management for remediation. 

Depending on your organization, these roles and titles may differ or not exist. However, the basic structure of these three lines helps keep vendor risk management responsibilities clear and consistent. 

Following the Vendor Risk Management Lifecycle

Vendor risk management also guides and oversees vendors through the vendor risk management lifecycle. All vendor relationships should follow a lifecycle of onboarding, ongoing, and offboarding activities, and a vendor risk management program helps keep these processes consistent and effective.

Here’s an overview of the three stages of the lifecycle and the activities involved in each one:

1. Onboarding – This stage sets the foundation for a safe vendor relationship by identifying and mitigating the risks that can impact your organization:
   • Planning & Risk Assessment – Planning involves choosing a vendor owner for the vendor relationship and deciding on an exit strategy, while the risk assessment determines the vendor’s criticality and identifies the types and amounts of inherent risk. All vendors should be classified as critical or non-critical, and given an inherent risk rating (usually low, moderate, or high). 
   • Due Diligence – The due diligence process is a risk-based activity, meaning that critical and high-risk vendors should be reviewed with more scrutiny. You’ll collect relevant information from the vendor, such as financial statements, SOC reports, insurance certificates, and business continuity and disaster recovery plans. The information should be reviewed by qualified subject matter experts (SMEs) who provide opinions on whether the vendor’s controls are sufficient.
   • Contracting – Selecting a vendor and negotiating and signing the contract are typically the final activities in the onboarding stage. It’s recommended to create a standardized set of terms and conditions for every high-risk and critical contract, which may include right to audit clauses, cybersecurity provisions, and insurance requirements.
2. Ongoing – Once you’ve signed the contract, it’s crucial to keep a close eye on your vendor relationships. Continuously monitoring and managing vendors is essential during the ongoing stage. You should be vigilant about identifying new and emerging risks and ensuring vendor performance meets your expectations and contractual requirements. Consider the following: 
   • Re-Assessments – The vendor owner should re-assess the vendor’s risk periodically to confirm nothing has changed in the relationship:
     • Critical and high-risk vendors should be re-assessed at least annually, or more frequently if there are any issues like data breaches or poor performance. 
     • Moderate-risk vendors can be re-assessed every 18-24 months. 
     • Low-risk vendors can be re-assessed every three years or upon contract renewal.
   • Monitoring & Performance – A vendor’s risk and performance can change throughout the relationship, so it’s essential to maintain a constant practice of ongoing monitoring. This can include monitoring negative vendor news or regulatory changes and using risk monitoring and alert services. Regular performance reviews are also helpful to identify any vendor issues, like a rise in customer complaints over the vendor’s service or prolonged service outages.
   • Renewals – Contracts should be reviewed mid-term, so your organization has enough time to determine whether any changes are necessary before the renewal period. Contract negotiations can be time-consuming, so it’s important to allow enough time for review.
   • Due Diligence – Certain due diligence documents can expire or become obsolete, like insurance certificates or a business continuity plan, so it’s important to repeat due diligence in the ongoing stage. This is necessary to ensure the vendor’s documents are current and valid. These ongoing reviews can follow the same cadence as risk re-assessments, but additional reviews may be needed before contract renewals or during performance issues or new regulatory requirements. 
3. Offboarding – Vendor relationships may eventually come to an end, whether it’s six months after the contract was signed, or six years. The activities during the offboarding stage will facilitate a safe ending of the vendor relationship: 
   • Termination – Your vendor should be formally notified that you’re not going to renew the contract or you’re terminating it early.
   • Exit Plan Execution – The exit plan should detail the tasks and responsibilities of both parties – your organization and the vendor. For example, your organization may need to return equipment, while your vendor must return or securely destroy your data.
   •  TPRM Closure – Any final administrative steps will fall under TPRM closure, such as updating the vendor status in your procurement system and paying any last invoices.

3 Types of Benefits From Vendor Risk Management 

Vendor risk management offers many benefits, though they aren’t always easy to recognize compared to other business functions like sales or finance. Many of the benefits from vendor risk management can fall under the following three categories:

1. Cost benefits – Contract management can prevent unwanted cost increases, while risk monitoring can help avoid potential regulatory fines and legal fees that arise from vendor data breaches. 
2. Strategic benefits – The due diligence process will help verify your organization is selecting vendors that can support your strategic goals and objectives. Performance monitoring and reporting can help identify vendors that are inhibiting your goals and objectives.
3. Operational benefits – Risk assessments will help your organization identify vendors that are critical to your operations, while due diligence can help determine whether those vendors can recover from business-disrupting events. 

Vendor risk management is a crucial function that’s often undervalued in many organizations. Some may view it as a mere regulatory requirement. However, effective vendor risk management can help manage costs, mitigate risks, and support operational resilience for the entire organization. By establishing the three lines of defense and following the vendor risk management lifecycle, organizations can reap the benefits of this essential business practice.