Third Party Risk: Definition, Examples, Management & Mitigation
LogicGate | February 26, 2023
One of the most difficult components of risk management is accounting for third-party risk. The vendors you count on for materials, the consultants you work with, the software solutions and tools your organization uses — all present their own set of risks.
Performing third-party risk assessment is critical to understanding what potential risks your organization faces in working with third parties. There's a long and storied history of companies suffering data breaches, reputational damage, and other operational snafus — or worse — due to their relationships with third parties and vendors.
Avoiding these risks requires a nuanced understanding of your third-party relationships, use of appropriate third-party risk management frameworks and tools, and organizational buy-in on the systems and processes needed to manage, assess, and mitigate this type of risk.
In this article, we'll lay out what third-party risk is, the different types of third-party risk you may encounter, provide some specific examples, and take a look at the tools you can use to manage it.
What is Third-Party Risk?
Third-party risks are any risks companies become exposed to by introducing external parties into their ecosystem, infrastructure, or supply chains. Third parties include vendors, suppliers, partners, contractors, or service providers that have access to any internal data related to systems, processes, intellectual property, customer information, or internal communications.
A critical point to remember about third-party vendors is that while your organization may have solid risk management and remediation plans in place, your third-party vendors may not uphold these same standards. Due to this dynamic, third-party relationships can increase vulnerabilities even in the most secure companies.
Hyperconnectivity and expanding services via third-party options have allowed companies to grow and make specific business processes more accessible and efficient, but it’s made it all that much more important to know exactly who has access to your company's data at all times..
Failure to manage third-party (or vendor) risks could mean regulatory action, financial loss, litigation, and reputational damage.
What Kind of Third-Party Risks Are Out There?
Third-party risks are numerous and diverse. Many large enterprise companies invest heavily in security and risk management, so cybercriminals have found that targeting suppliers and partners with connections to these larger entities but less sophisticated defenses often represent an easier path into a far more valuable target.
An attack on a smaller vendor can rapidly expand through cloud-based connections and infect a larger target companies' systems (and the networks of all of its other partners and, potentially, clients) via connected devices and supply chain interconnectedness.
Typically third-party risks that impact enterprise businesses fall into the following categories:
Financial risks damage your company’s financial performance and impair sales or other revenue-generating operations, causing revenue goals to fall short. Financial troubles at a vendor or third party up- or downstream in your supply chain can lead to financial problems for your own organization.
Reputational risk is the risk that a relationship with a third party or vendor could lead to some sort of controversy, security breach, or legal entanglement that damages public opinion of your company.
Regulatory and Compliance Risks
Regulatory and compliance risks occur when third parties do not follow laws, rules, or regulations, or or fail to comply with your internal policies or procedures or their own. Any such failure by a third party has the potential to leave your organization on the hook by association, as well.
Operational risks are any loss from disrupted business operations, such as the loss of a facility due to natural disasters or a cyber attack that brings down the principal company's operational systems. If a crucial piece of your supply chain is in an area that just experienced a major earthquake, for instance, it could cripple your ability to obtain raw materials, even if your own assets and facilities are located across the globe.
Strategic risks come about when an organization makes adverse business decisions or to implement appropriate business decisions consistent with its strategic goals. In other words, you’re opening yourself up to strategic risk by choosing the wrong third-party entity to perform critical functions.
Examples of Third-Party Risk
While we touched on what the different types of third-party risk are, let's get into some specific examples of potential threats. These examples only scratch the surface of third-party risks an organization could face.
If a supplier violates labor or environmental laws, your organization could still be found liable and face fines.
If a software vendor is hacked, your organization could be left with a downed system.
A supplier's inventory could be impacted by a natural disaster, leaving your own supply chain in chaos.
Healthcare systems rely on hundreds of vendors to perform critical operations. Organizational risk occurs if any of these are interrupted: transportation, security, laundry, and waste removal, to name a few.
A critical third-party vendor could be limited on credit or operating cash flow, and fails to deliver on a contract or goes out of business.
A supplier could provide a faulty component to a larger product that results in recalls or defective products - or outright failed product delivery.
A cybersecurity breach to a third-party password manager can leave your organization's valuable data and assets exposed.
What is Third-Party Risk Management (TPRM)?
Third-party risk management (TPRM) is how companies analyze and control risks involved with vendors and service providers. TPRM is often carried out with the support of frameworks, which provide organizations with roadmaps for building their TPRM programs based on industry-standard best practices.
As a first step for managing third party risk, you should conduct a vendor assessment. These assessments often involve the vendor completing a questionnaire to help you understand the risks associated with them. They are critical tools for creating risk mitigation plans.
Third-party risk management's goal is to reduce the possibility of data breaches, operational failures, vendor financial malfeasance, and to ensure all vendors are operating in compliance with regulatory requirements.
How Having Efficient TPRM Programs Help Companies
Third-party risk management programs can be complex, dispersed, multi-layered, and information-heavy. If your company employs third parties, you need to give your employees the ability to manage the associated risks effectively. When companies put proper TPRM frameworks and tools in place, managing risk becomes much easier.
Say one of your marketing leaders needs to find new vendors yesterday for a mission-critical campaign. They must vet a handful of possible vendors, all with different security practices and standards in place. To do so effectively, the marketing leader needs to check each vendor’s experience and performance and ensure that due diligence has been done to make sure both organizations are aligned on privacy, security, and compliance.
So who should own TPRM in your organization? The reality is that everyone in the organization should care about TPRM because each department within an organization is using different vendors and contractors to get their work done. While you should have a dedicated risk management team to handle your organization’s overall risk program, encouraging everyone to think like a risk manager leads to a better understanding of potential risks and ultimately to better vendor relationships.
Ways To Assess Third-Party Risk with Vendors
We covered this in detail in our article on third-party risk assessment, but to reiterate, here are some high level ways you can assess third-party risks.
Identify risks in your existing vendor ecosystem - Create a risk register of all potential risks based on subject matter expert interviews, data analyses, reviews of external media, and any other data points you can find.
Create risk profiles for vendors - Map each identified risk to the vendor that poses it to develop risk profiles. You can group vendors together based on similarities.
Tier vendors based on risk level - Different vendors pose different levels of risk. By bucketing them, say, into high, medium, and low categories, you can begin assessing and mitigating risk based on priority.
Evaluate their security posture and data access - Questionnaires and checklists can be really helpful to glean more information about a vendor's security posture, and whether they're compliant with your desired security frameworks. You can also check in on their financial state to ensure they're a reliable, long-term partner.
Decide how to address the posed risk - You can avoid the risk by deciding not to do business with a vendor that exceeds your risk appetite, accept the risk with ongoing monitoring, mitigate the risk or transfer the risk to (usually) an insurer.
Enact ongoing assessment - Continually evaluate third-party vendors by implementing regular assessments in your vendor lifecycle. If a new regulatory threat is on the horizon, or a vendor's access changes, you'll want to have measures in place to ensure they are re-evaluated.
Employ the help of TPRM software - Scale your vendor risk management by automating your process with a modern GRC platform, like LogicGate Risk Cloud®.
Important Questions To Ask Third-Party Vendors
When onboarding third-party vendors, it's important to get a complete inventory of their security practices, financial state, and any other information to get a risk score for the potential risk they pose.
One way to kick this off is with questionnaires, surveys, and evaluations aimed at assessing the risk of working with them.
This list is obviously not exhaustive, but it’s a sample of the types of questions you should ask:
Can you provide any industry standard security certifications your organization holds?
Can you provide a penetration test report from within the past year?
Does your organization have cyber security insurance?
Does your system or application support SSO?
Can you provide terms and conditions applicable to our arrangement?
Has your organization ever been the defendant in a criminal case?
Is your company registered in a non-US country?
Has your company ever experienced a security breach?
What types of data will your system or service be storing, processing, or accessing?
Introducing Fourth-Party Risk
Third-party relationships often have exponential scale. You have to think about not only the vendor or partner you're introducing to an organization's risk ecosystem, but also the vendors and partners that organization works with.
For example, if one or more of your critical suppliers or vendors is forced to halt operations due to a data breach to one of their critical suppliers or vendors, that can have a major impact on your organization. Since it's a fourth party who has no direct relationship to your organization, it's unlikely you would be privy to their business continuity plan, if one even exists, unless you obtained that information from your vendor.
How To Assess Fourth-Parties
In many ways, fourth party risk seems unmanageable, but having an effective third-party risk management program in place can actually mitigate quite a bit of this risk.
Comprehensive due diligence on third-parties can go a long way. When entering a contract with a third party, you should already understand the level of involvement of fourth parties needed to execute the terms of that contract. You can introduce contractual clauses, for example, stating that if these relationships change or evolve in any way, your organization needs to be notified immediately.
You can also go the extra mile and evaluate critical fourth-parties prior to entering a relationship with the third party. This is often only necessary when a fourth party is integral to terms of your agreement. For example, if you know that your third party is relying on a subcontractor to deliver a significant portion of the products or services you need, it makes sense to evaluate them as well.
Another layer to consider is assessing your third party’s and vendors' third-party risk programs. It's important to be certain that they are performing due diligence through an effective TPRM framework. If you're not confident that they have the appropriate systems and processes in place to evaluate third parties effectively, you should either decline to work with them or put safeguards in place on your end if you do choose to continue the relationship.
LogicGate Helps Mitigate Relationship Risk
LogicGate's Risk Cloud platform helps companies identify red flags, steer clear of overly risky relationships with third parties, and stay on top of any risk introduced by third parties who you must work with. Our TRPM solution offers companies the support needed to help control their third-party relationships. With Risk Cloud you can:
Streamline vendor assessment process with the help of automated questionnaires and assessments.
Protect your data with the help of external user multi-factor authentication.
Encourage better collaboration between multiple stakeholders and external vendors.
Our proactive Applications are designed to meet your business's needs with easy-to-build and track processes that assure you that your third-party relationships have solid foundations.