No organization can operate in a vacuum in today’s interconnected business world. Like every company, you rely on a network of vendors, suppliers, service providers, partners, and more. They supply you with raw materials or hardware for your devices, provide IT tech support or outsourced customer services, work with you as consultants or contractors, deliver SaaS tools, cloud platforms, payment processing, and more.
Each third-party exposes you to potential risks, which could be financial, cybersecurity, operational, or other types of risk. Some of the fallout is obvious and immediate, while other effects only become evident later on.
It’s vital to assess possible third-party risks and evaluate how effectively they address those risks, otherwise they may cause serious harm to your business. Companies that fail to manage third-party risk can end up facing significant financial consequences, from fines and penalties to lost revenue and lower profits over the long term.
In this article, we’ll explore both the direct and hidden costs of third-party risk, and discuss actionable steps you can take to mitigate them for your organization.
Understanding Third-Party Risk and Its Financial Implications
Let’s begin by defining third-party risk. Essentially, it means any potential harm that could come to your organization through a third party. Third-party risks include:
- Cybersecurity risks, including the risks of malware, ransomware, data breaches, phishing attacks, and remote access vulnerabilities;
- Compliance risks if third parties don’t adhere to regulatory standards and meet the requirements of various regulations;
- Operational risks, such as service outages or delayed shipments of components you need to maintain business continuity;
- Reputational risks that harm your brand image and cause customers to leave your company and favor the competition;
- Financial risks, including fines and penalties, lost revenue, and the cost of remediating cyber attacks.
How Ignoring Third-Party Risk Leads to Financial Repercussions
It might be tempting to sweep third-party risk under the carpet and hope it won’t affect you, but that would be a mistake. If you ignore third-party risk, you won’t know what kind of threats may affect you, and you won’t take any action to prevent them.
The consequences of these threats can be severe. Direct costs alone can mount to millions of dollars, once you add up the cost of dealing with data breaches, fines and penalties levied by regulatory authorities, and the revenue that you miss due to service outages and lost productivity.
And that’s before we consider the indirect financial effects of third-party risk. A broken reputation is expensive to fix and might never be repaired. Damaged customer trust, lower stock prices, missed opportunities when investors and partners decide not to do business with you — it all mounts up and harms your bottom line, sometimes for years.
Key Financial Consequences from Ignoring Third-Party Risks
The main direct results of ignoring third-party risks tend to hit your organization within a very short timeframe and can cause significant damage. They include:
- Data breaches and cyber incidents that cause financial losses
- Fines and penalties levied by regulatory authorities for non-compliance
- Operational disruption and lost productivity from unplanned downtime
Let’s take a closer look at these consequences.
Data Breaches and Cyber Incidents
Malicious actors take advantage of the interconnectedness of today’s supply chains to use your third parties as a back door to your ecosystem. All it takes is one vendor with poor cybersecurity measures or weak phishing awareness training. Once cybercriminals gain entry to those networks, they can move laterally through the supply chain to reach your systems.
Sometimes attacks can go unnoticed for months, allowing attackers to disrupt your business-critical systems and/or steal sensitive data. The cost of remediating breaches, restoring business operations, and resolving stolen data can be considerable, plus you miss out on revenue while your company isn’t operational.
Regulatory Fines and Legal Costs
Organizations today have to adhere to many regulations, including industry standards and regional and international requirements. Regulations like GDPR, HIPAA, and SOX apply significant fines to companies that don’t comply with all their obligations, even if the worst doesn’t happen and you don’t experience a data breach.
If a data breach does occur, you could face even higher financial penalties. Sometimes customers whose personal information was stolen sue the company involved, and occasionally regulatory authorities themselves lead lawsuits against non-compliant organizations. Even if you win the case, legal fees mount up and eat into your income.
Operational Downtime and Disruptions
If your third parties fail financially, suffer a cyber attack, get hit with natural disasters, or encounter any of a number of difficulties, they might not be able to fulfill their promises to your organization.
If you’re relying on them for business-critical services, this could have a knock-on effect that leaves you unable to meet your own deadlines and causes you to disappoint customers. Lost productivity can translate into lost revenue from the sales that fall through, or high costs from emergency response measures that enable you to deliver products or services on time.
The Hidden Costs of Ignoring Third-Party Risks
Direct costs can have a serious negative impact on your financial viability, but they may be the tip of the iceberg. Hidden or indirect costs can leave you hemorrhaging even more money, sometimes for months or years. These include:
- Reputational damage and broken customer trust
- Lost business opportunities as partners decide to avoid your organization
- Higher insurance premiums due to your greater risk profile
- Extra remediation costs for audits, system overhauls, and vendor replacements
- Lower stock prices and missed investor opportunities
Here’s a deep dive into each of these aspects.
Reputational Damage
It can take years to build a positive brand reputation, but poor third-party risk management can destroy it overnight. Data breaches, non-compliance, and operational disruptions can cause people to see your organization as one that doesn’t deliver on time, care about data security, or adhere to regulations.
This negative reputation can damage customer trust and induce them to buy elsewhere. You might lose a significant percentage of your market share or even face long-term financial decline. The cost of regaining trust can be considerable, including sustained PR efforts, extra marketing spend, discounts to entice customers to return, and sometimes extensive rebranding.
Loss of Business Opportunities
Once you’ve gained a bad reputation for downplaying third-party risk, it can come back to bite you in all kinds of ways. Other companies might hesitate to link their name with yours in case they get tarred by your negative image, which can cause you to miss out on business opportunities with potential partners.
Lucrative clients might decide to work with your competition instead of risking a connection with a company that’s suffered a data breach or been fined for non-compliance. When contracts do come your way, the terms might not be as favorable as they could have been.
Increased Insurance Premiums
Insurance is a significant but unavoidable cost of doing business. It’s never safe to operate without sufficient insurance, but at the same time, you want to keep those insurance premiums as low as possible.
Insurance companies set their premiums according to the level of risk they perceive for your company. If you’ve experienced a third-party incident like a data breach or operational disruptions, you can expect that your insurance company will raise your premiums, affecting your ongoing expenses.
Remediation Costs
Fixing a third-party incident can rumble on for months, costing you money all the time. As well as immediate patches like improving your cyber defenses or closing known vulnerabilities, you are likely to need ongoing projects to manage third-party risks for the long term.
These can include overhauling your entire business systems and cybersecurity defenses, replacing your vendors with others who are more reliable or have a more positive reputation, and dealing with frequent audits from regulatory authorities which are now keeping a close eye on your risk posture.
Loss of Investor Confidence
A damaged reputation can linger for a long time, and affect you in more ways than you’d expect. If people perceive your organization as having been damaged financially by a third-party incident, it can play out in falling share prices and lower rankings on stock market indices.
Investors are also more likely to invest in a company that has a robust approach to third-party risk than in one that’s already suffered from underestimating or ignoring its third parties. Anything that affects your image of financial stability can have an effect on your long-term appeal for investment and acquisitions.
Mitigating Financial Risks Through Effective Third Party Risk Management
The good news is that there are effective steps that you can take to mitigate third-party risks and protect your organization from potential third-party incidents like data breaches and operational disruption. These include:
- Carrying out due diligence when onboarding new vendors
- Establishing ongoing monitoring for third-party risks
- Following cybersecurity best practices
- Embedding safeguards into contracts
- Implementing third-party risk management (TPRM) solutions
Comprehensive Vendor Due Diligence
It’s vital to thoroughly assess every new vendor’s risk profile before you work with them. Security questionnaires, security ratings, reviewing their cybersecurity policies, and running penetration tests and audits are all important aspects of vendor due diligence.
Consider their financial stability, compliance with relevant regulations, exposure to natural disasters, and history of past incidents, to create a full evaluation of their risk profile.
During assessments, keep in mind their level of data access and how business-critical their services are. Vendors with access to your sensitive data and/or whose services are crucial for business continuity need stricter assessments.
Ongoing Monitoring of Third Party Risks
Initial onboarding assessments are important, but they aren’t enough alone to keep third-party risk under control. You need to continue monitoring your third parties throughout your working relationship.
This involves tracking changes to their cybersecurity policies or compliance profiles, monitoring access to your systems and data, and verifying that they install software patches and updates on schedule. By constantly tracking and auditing third-party activities, you can detect potential risks before they escalate, and take action to mitigate them before they harm your company.
Cybersecurity Best Practices
Cyber attacks are possibly the single biggest threat from third-party risks, so it’s crucial to prioritize it in your third-party risk management (TPRM) strategies. This means implementing cybersecurity best practices across all your third parties, and ensuring that your vendors follow suit for their third-party networks.
Cybersecurity best practices include rigorous access controls and monitoring, as well as tracking changes to permissions and unusual entries to your systems. It should also involve effective and swift incident response, with rigorous reporting and regular audits.
Contractual Safeguards
Your third-party contracts should include clauses that mandate monitoring and mitigating risk. Specify the cybersecurity standards that vendors need to adhere to, define robust Service Level Agreements (SLAs) about their security obligations, and outline the frequency required for audits, reports, and security reviews.
Contracts should also establish liability in the event of incidents like data breaches, and list the regulations and industry standards that you expect vendors to comply with. Include details about vendor responsibility to monitor their own third parties, and be precise about protocols for notifying you about any incidents.
Third-Party Risk Management Platforms
Third-party risk management is much easier and more efficient when you use TPRM tools. Solutions like Panorays can streamline vendor risk assessments by automating much of the process, and use AI and ML for more reliable, real-time monitoring.
AI-powered automation makes it easier to send customized security questionnaires, and takes over the work of collecting, verifying, and evaluating responses and producing reliable scores. TPRM platforms can also deliver continuous monitoring, applying ML to spot the earliest signs of potential threats so you can deal with them before they escalate.
Third-Party Risk Management Solutions
The financial consequences of poor third-party risk management can be significant and long-lasting. On top of the immediate loss of revenue and impact of fines and penalties, the indirect costs of damaged reputation and missed business opportunities can quickly mount up and overwhelm your profits.
Concern for your bottom line should be enough to convince every organization about the need to take TPRM seriously and implement effective third-party risk management strategies. It’s not enough to apply fixes and remediation after an incident occurs. You need proactive TPRM to ensure business resilience and protect your organization from third-party threats.
To make sure that your third-party risk management strategies, tools, and protocols are effective at safeguarding your financial stability, it’s a good idea to review them periodically. Verify that there aren’t any gaps and that they provide holistic protection against the full range of third-party risk.
Ready to protect your organization’s financial stability? Get a demo of our third party risk management platform today.
Third Party Risk FAQs
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Poor third-party risk management can have long-lasting and severe results for your business. It can damage your brand reputation, affect your financial stability, cause you to lose market share and miss out on business opportunities.
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The risks of poor third-party risk management can be widespread. You might end up experiencing cyberattacks and data breaches, face fines and penalties for non-compliance with regulations and industry standards, and lose productivity and business continuity due to operational disruptions.
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Examples of third-party risk management include carrying out due diligence before working with a vendor, carrying out regular audits, including contractual obligations that require third parties to meet your security standards and vet their own third parties, and setting up continuous monitoring to track changes to third-party risk posture.