Vendor Risk Management: Audit Checklist, Workflow, Reporting, Benefits, Best Practices

Today, organisations are increasingly relying on third-party vendors to improve their operations and increase growth. These partnerships bring multiple benefits but also several serious risks. It may cause disruption to business continuity and damage to the company’s reputation. 

Therefore, every large enterprise must have a strong vendor risk management programme in place to detect, measure and overcome vendor-related risks. In this article, we cover the key aspects of vendor risk management, such as audit checklists, workflows, reporting mechanisms, advantages and best practices.

What is Vendor Risk Management?

Vendor risk management (VRM) is a continuous due diligence process to identify, evaluate, manage and mitigate the risks resulting from third-party vendors and business partners for the duration of a business contract. The process helps an enterprise acknowledge red flags related to poor data security controls, cyber security failures, regulatory violations and supply chain disruptions that can be avoided with timely intervention. 

A properly structured VRM programme will make sure that the vendors are working in compliance with the company’s security policy and regulatory standards to protect sensitive business information while the business contract is active.

Types of Vendor Risks

Vendors hold the potential to destabilise business operations with various types of risks, such as:

Operational Risks: This risk stems from internal or external events with the potential to disrupt services provided by a vendor. (ex: natural disaster, fire hazards)

Compliance Risks: This risk arises when a vendor fails to adhere to laws, regulations, or contractual obligations, potentially exposing your organisation to legal penalties. (ex: not filing GST returns on time)

Reputational Risks: These are risks associated with a vendor’s actions or failures that harm your organisation’s public image or stakeholder trust.

Financial Risks: This risk arises due to your vendor’s financial instability to meet your on-time service requests and product deliveries could hamper your own delivery commitments along the supply chain. 

Cybersecurity Risks: These risks stem from unauthorised access to sensitive data through a vendor’s systems, potentially leading to data breaches or cyberattacks.

Vendor Risk Management Audit Checklist

It is important to perform vendor risk management through periodic audits. In this regard, a vendor risk management audit checklist can help you look at every conceivable angle for red flags. In general, the checklist includes the following metrics for review:

1. Vendor Assessment:

Your vendors are your long-term business partners. Their stability and ethics directly impact your success. So, evaluate and monitor aspects such as their-

• Financial health: Evaluate whether the vendor is financially stable and capable of meeting obligations. 
• Compliance: Investigate any missing compliance links to ensure adherence to relevant laws and standards.
• Operational capabilities: Look into the vendor’s performance history, delivery timelines, and overall reliability.

2. Data Security and Privacy:

Your data is your lifeline, and your vendors must treat it with the same level of care. A single data breach caused by a careless vendor can cost your company lakhs and crores of rupees — not just in fines, but in lost customer trust.

• Check if your vendor has robust data protection policies to safeguard your sensitive information.
• They should be in compliance with data privacy laws specific to your industry, ensuring that you remain on the right side of the law.

3. Contractual Agreements:

It’s important to include clauses in your regular audits so that you can continuously verify compliance. For instance, your service level agreements (SLAs) should state that your machinery supplier must provide replacement parts for free if you experience production halts during the warranty period. 

4. Business Continuity and Disaster Recovery:

Assess your vendor's plans for disruption and their disaster recovery strategy for post-disaster service recovery time. What if their service disruption after any natural disaster grinds your production to a halt? Never forget to check if your vendors are capable of operating under emergencies.

5. Subcontractor Management:

Remember to check if the vendor employs any subcontractors, and assess associated risks — but be sure those subcontractors are as consistent with the same standards and policies as the primary vendor. You should also additionally review the vendor's process of managing and monitoring subcontractor performance to avoid unpleasant surprises. 

Vendor Risk Management Workflow

Implementing a structured workflow streamlines the vendor risk management process. A typical workflow includes:

1. Vendor Identification and Risk Classification:

• Inventory all vendors and categorise them based on criticality of their services (e.g., strategic, operational, or low-risk).
• Assess the level and type of access they have to sensitive data or systems.

2. Risk Assessment:

• Carry out risk assessments to find out what the threat is in regard to each vendor.
• Assess the consequence and probability of risk identification on organisational operations.

3. Due Diligence:

• Perform thorough background checks, including financial stability and compliance history.
• Assess the vendor's security measures, policies, and procedures.

4. Contract Negotiation:

• Include defining terms and conditions as clearly as possible along with the responsibility for risk management.
• Establish strong SLAs and key performance indicators (KPIs).

5. Ongoing Monitoring:

• Ensure vendor performance is tracked regularly against set SLAs and KPIs.
• Perform periodic audits and assessments of emerging risks.
• Keep an open channel for reporting irregularities and resolving issues.

6. Strengthening Cybersecurity and Data Protection

• Require vendors to follow cybersecurity best practices (e.g., encryption, multi-factor authentication).
• Implement access controls to limit vendor access to critical systems.
• Ensure vendors follow a data breach notification protocol and incident response plan. 

7. Termination and Offboarding:

•  Develop a formal process for terminating vendor relationships when necessary.
•  Ensure the return of or secure destruction of sensitive data upon contract termination.
•  Review and update internal records to reflect the end of the vendor relationship.

How to Manage Vendor Risks

Effective management of vendor risk involves:

• Establishing a VRM Framework: You develop policies and procedures that define how the organisation assesses, manages, and mitigates vendor risk.
• Conducting Regular Training: Teach staff how to utilise the VRM processes to identify risks at various levels of vendor management.
• Utilising Technology Solutions: Implement VRM software to drive automatic assessments, monitoring, and reporting.
• Fostering Strong Vendor Relationships: Keep in touch with the vendors so that you and your vendors can mitigate risks together.

Examples of Vendor Risk Management

Let’s take some hypothetical vendor risk management scenarios for better understanding.

1. Data Breach Prevention: 

An IT company working with a cloud service provider includes regular penetration testing and encryption audits in its vendor risk management plan. This ensures sensitive data remains protected, reducing the chances of a breach.

2. Regulatory Compliance: 

Legal advisors for a financial institution should work hand in hand with the payment processing vendor to determine if the institution's payment processing vendor complies with GDPR and other data privacy laws. This serves to ensure zero risk of regulatory fines or loss of customer trust.

3. Business Continuity: 

The role of a logistics company is to evaluate what their supply chain vendors’ disaster recovery plans look like so they can see operations continue in the case of any natural disasters and the like.

4. Performance Monitoring: 

An e-commerce platform uses KPIs to monitor its warehousing vendor's efficiency in fulfilling orders. Any dip in performance triggers corrective actions to maintain customer satisfaction.

Benefits of Vendor Risk Management

A well-executed vendor risk management programme offers several benefits, including:

1. Improved Security: 

Regular review of vendor security will reduce the risk of data breaches and cyberattacks by limiting how much bare vulnerability is allowed into the organisation.

2. Regulatory Adherence: 

Vendor risk management serves as a way for organisations to prevent vendors from violating any law or regulation and get out of legal limbo.

3. Operational Resilience: 

With vendor risk management clearly understood, and mitigation strategies and disaster recovery plans in place, organisations can continue their business through the disruption.

4. Enhanced Vendor Relationships: 

Transparent communication and collaboration foster trust, leading to more productive and reliable partnerships.

5. Cost Savings: 

Identifying potential risks early prevents costly incidents such as data breaches, legal disputes, or operational disruptions.

6. Better Brand Reputation: 

Incidents that damage a firm's public image and customer confidence can be minimised through proactive risk management.

Vendor Risk Management Best Practices

To optimise the vendor risk management process, consider the following best practices:

1. Segment Vendors by Risk Level: 

Break down vendors into permissibility and the criticality of their services. Assess and monitor high-risk vendors first. For high-risk vendors, conduct quarterly reviews, while medium- and low-risk vendors can be reviewed semi-annually or annually.

2. Implementing Continuous Monitoring: 

Monitor vendor performance, compliance and risk levels on a regular basis. Leverage automated tools to get real-time notifications for missed SLAs or changes in a vendor’s financial health. In India, buyer enterprises are dependent on vendors for their input tax credits, hence continuous monitoring of GST return filing is also crucial.

3. Incorporate Risk Assessments Into the Onboarding Process: 

Use your pre-onboarding vendor checklist during the vendor selection and onboarding process to ensure only reliable and compliant vendors get onboarded.

4. Leverage Technology: 

Use vendor risk management software to streamline workflows, automate assessments, and generate detailed reports. However, the software must integrate well with your existing systems for seamless data sharing.

5. Establish a Vendor Exit Plan: 

Have a clear offboarding process in place to terminate vendor relationships, recover assets, and securely delete sensitive data when necessary.

An effective approach to managing vendor risks depends on a structured approach and appropriate tools. As vendors become more complex to manage and as regulations enforce automation of workflows and streamlining of processes, vendor risk management software automates risk assessments, simplifies workflows and ensures compliance, becoming increasingly valuable to organisations.