How to Identify Third-Party Risk

How to Identify Third-Party Risk (Third-Party Risk Series Part 1 of 3)

It’s complicated enough to manage your own company’s risk, let alone risks caused by third parties. But without a proper understanding of third-party risks, your company is ill-prepared to mitigate its potential dangers. 

To help your company reduce its overall risk, we’re creating a three-part series on third-party risks. The series will explore the following topics:

1. What is third-party risk?
2. How to assess third-party risk
3. How to manage third-party risk

Join us for Part 1 as we study third-party vendors and how to identify the various risks they pose to your company.

What Is a Third Party in Business?

In the business world, a third party is any outside entity or vendor that works with your company to provide services or products. This includes, but is not limited to, suppliers, manufacturers, intermediaries, licensees, agents, and business partners. For example, a hospital might engage a third-party medical device company in order to purchase more equipment for patient care. Or, a bank may use third-party software in order to protect private customer data. Usually, the third party signs a written agreement to supply goods or services for your company.

Why Collaborate with a Third-Party Vendor?

Every company needs the help of a third party in order to do business. Whether it’s bringing supplies in or sending work out, no business has the capacity or expertise to manage everything alone. Chances are, your business already collaborates with hundreds, if not thousands, of third-party vendors. In fact, 60% of companies report working with over 1,000 third parties. As the business world continues to grow and diversify, these numbers are projected to increase over time.

So, while you may have a business need to engage a third-party vendor, it’s important to understand the inherent risks. That’s why evaluating and conducting due diligence of third parties is so important before forging a business relationship. Strong, compliant partnerships with third parties can boost your company’s productivity and even its reputation. However, if a third party you work with does something wrong, your business becomes vulnerable and potentially even liable.

The Six Main Types of Third-Party Risk

While third-party companies can be a huge asset for your company, it’s important to be cautious about who you partner up with. Companies must be able to identify and categorize the major risks different third-party groups pose to their organization.

1. Cybersecurity Risk

Cybercrimes happen at an alarming rate in today’s digital age. Attackers infiltrate a company’s software, potentially leaking, stealing, or destroying data and private information. Unfortunately, third-party companies are a common target, as attackers use them as a means of infiltrating higher-level targets. Breaches of your company’s cybersecurity will not only corrupt data, but corrupt your consumers’ trust in your organization.

2. Financial Risk

Most third-party companies cost money, and where there’s money involved, there’s risk. If the third-party company is inefficient, delivers low-quality work, or is generally not a good fit for your business, your company risks losing more than it’s gaining. In the worst-case scenario, a compliance violation from a third-party vendor could cost your business steep fines and litigation fees. GlaxoSmithKline (GSK), Biomet, Novartis, and many other life science companies have paid millions to resolve alleged bribery performed by third parties.

3. Compliance/Legal Risk

When you introduce a third party into your organization, that third party becomes a compliance risk that you may have some level of responsibility for. Even if your company has a strong compliance culture, any third-party violations of state or federal laws can potentially get your business into trouble, too. To avoid compliance risk, only partner with companies that meet your company’s rigorous compliance standards. 

4. Operational Risk

In some cases, third-party vendor issues have the potential to hinder or even shut down your business operations. For example, if your company’s supplier delivers products late, or your company’s website host crashes, your business may experience disruptions. These disruptions can range from minor problems to major crises, depending on the criticality of the affected third-party vendor. To minimize operational risks, be sure to evaluate the third party’s ability to meet your business needs.

5. Reputational Risk

As business magnate Warren Buffet once said, “It takes 20 years to build a reputation and five minutes to ruin it.” While your company might quickly bounce back from financial or operational setbacks, it can be much harder to recover from reputational damage caused by a third party. Companies must carefully vet their third-party options to ensure they have strong reputations and ethical standards before settling on a vendor.

6. Strategic Risk

A strong partnership with a third party should fit seamlessly into your company’s business objectives. The less your two companies align, the more of a strategic risk your company takes on. As such, carefully consider how a third party’s business culture meshes with your company’s goals and future trajectory.