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Third-Party Risk Scoring: A Comprehensive Guide
Published on:
September 16, 2024
Ajay Ramamoorthy
Senior Content Marketer
Karthikeyan Manivannan
Head of Visual design
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In a highly interconnected business world, organizations rely on third-party vendors to provide services, products, and technologies. While these partnerships offer efficiency and innovation, they also come with significant risks. These risks expose businesses to vulnerabilities outside their control. To manage these risks effectively, businesses use third-party risk scoring, which is a structured method to evaluate the potential risk a vendor could pose to a business. 

What this blog will cover:

  • What is third-party risk scoring?
  • Why is third-party risk scoring important?
  • How to score third-party risk?
  • Best practices for third-party risk scoring
  • Frequently asked questions about third-party risk scoring

What is Third-Party Risk Scoring?

Third-party risk scoring assigns a value to the potential risk an external supplier brings to an organization. It is done based on factors like security practices, financial health, and compliance. Third-party risk score helps identify threats early to reduce the chances of data breach or compliance failures. 

Third-party risk scoring typically evaluates areas such as: 

  • Financial Health: Ensuring the financial stability of the vendor for long-term viability. 
  • Cybersecurity Posture: Assessing vendor’s ability to protect data. 
  • Compliance: Ensuring the vendor follows legal and regulatory rules. 
  • Operational Resilience: Evaluating vendor’s ability to continue providing services.  

Why is Third-Party Risk Scoring Important?

Third-party risk scoring is a structured approach to evaluate the risks associated with external vendors, suppliers, and service providers. These risks can include financial, operational, or cybersecurity threats. By assigning risk scores, businesses can measure potential risks associated with new and existing vendors.

Here are some reasons why third-party risk scoring is crucial:  

1. Protects Business Continuity

Third-party risk scoring enables businesses to identify high-risk vendors that might compromise security and operations. For instance, if a key vendor experiences a data breach or operational failure, it can disrupt your business processes too.  By regularly assessing your vendors,  you can prevent such disruptions and ensure business continuity. 

2. Enhances Compliance and Regulatory Adherence

Ensuring compliance with regulations like GDPR, HIPAA, PCI, DSS is top priority for many industries. Vendors who handle sensitive data must also comply with these regulations. By using a risk score, businesses can ensure vendors meet compliance requirements and avoid legal penalties or fines. Risk scoring makes it easier and efficient to spot gaps and address them proactively before they become issues. 

3. Safeguards Financial Investments

A third-party vendor's financial health vendor's financial health is key to reliable service delivery. If a vendor is financially unstable, they may go out of business, fail to deliver services or compromise quality. Risk scoring evaluates financial stability, allowing companies to avoid vendors that pose a financial risk and ensure better ROI. 

4. Reduces Reputational Risks

A business is only as strong as its reputation. Working with high-risk vendors can lead to public scandals, data breaches, or other reputational damage. Risk scoring is an effective way to avoid vendors with poor performance or legal issues. This protects your brand image and maintains trust with customers and stakeholders. 

5. Improves Vendor Accountability

Assessing a quantifiable risk score, encourages your vendors to maintain high standards in order to continue doing business with you. Low-scoring vendors can be held accountable and high-scoring vendors can be trusted to continue business operations with fewer restrictions. 

6. Informs Strategic Decision-Making

The data from third-party risk scoring can be used to formulate broader business strategies. For example, knowing which vendors have high risk scores can guide you to make better decisions on contract negotiations, vendor selection and resource allocation. 

How Do You Score Third-Party Risk?

Scoring third-party risk involves evaluating vendors based on key risk categories like cybersecurity, financial stability, and compliance. By collecting vendor data, analyzing risk factors, and implementing continuous monitoring, businesses can make informed decisions about vendors and vendor relationships. 

Here are the steps to effectively score third-party risk: 

Step 1: Establish Risk Categories

Begin by identifying key risk categories that are relevant to your business. These can include cybersecurity, financial stability, regulatory compliance, and operational resilience. Each category should have measurable metrics that can be tracked and managed. For example, cybersecurity can be measured by finding out whether the vendor is using encryption and adheres to data protection compliance standards. 

Step 2: Collect Vendor Data

Gather information about each vendor using a mix of self-reported data (like questionnaires) and third-party sources (like financial audits or security certifications). Make sure to cover all relevant areas, including financial reports, IT security policies, compliance records, records of past security incidents. 

Step 3: Analyze and Assign Scores

Using the data you gathered, evaluate the vendor’s risk in each category. Assign scores to each vendor based on their performance as per industry standards. You can use a simple numerical scale (like 1-5 or 1-10) or a detailed scoring system that factors in various risk levels. High risk scores should reflect low-risk vendors and low risk scores should signal high-risk vendors. 

Step 4: Implement Continuous Monitoring

Vendor risk is not static, and it changes over time. Implement a system to regularly review and update each vendor’s risk scores based on new data, such as financial reports and cybersecurity incidents. This can be automated using third-party risk management platforms that offer real-time monitoring and risk updates. 

Step 5: Make Informed Decisions

After the scores are assigned, use them to guide your decisions on vendor relationships. High-risk vendors may need to implement additional safeguards, while low-risk vendors can enjoy more streamlined contract negotiations. Continuous monitoring ensures that businesses are always aware of the evolving risks and can act quickly to mitigate them. 

Third-Party Risk Scoring Best Practices

Effective third-party risk scoring involves using automated tools for risk scoring, adopting a risk-based approach, and maintaining clear vendor communication. By regularly updating risk scores and conducting onsite audits, businesses can ensure accurate assessments and better manage vendor relationships.

Here are the best practices for scoring third-party risk:  

1. Use Automated Risk Management Tools

Using automation tools to collect and assess data from vendors can significantly streamline the risk scoring process. These tools not only speed up the risk scoring process but also reduces the likelihood of human error. Automation ensures that you are always working with risk related data that is real-time and up to date.

2. Adopt a Risk-Based Approach

Not all vendors pose the same level of risk to your business. Focus your resources on high-risk vendors who have the most impact on your operations, finances or compliance requirements. A risk-based approach ensures that you are not wasting resources on low-risk vendors and that your focus is more on those that matter most. 

3. Maintain Clear Communication with Vendors

It is essential to have transparent communication with your vendors about risk management. Set clear expectations about what data they need to provide and how they can improve their scores. A collaborative approach ensures that vendors understand the importance of risk scoring and are more likely to comply with your security and compliance demands. 

4. Regularly Update Risk Scores

A vendor’s risk score can change over time due to new regulations, economic shifts or cybersecurity incidents. Ensure that risk scores are regularly reviewed and updated. Set up periodic audits and use continuous monitoring tools to keep track of any changes in a vendor’s risk profile.  

5. Perform Onsite Audits for Critical Vendors

For vendors that provide critical services or handle sensitive data, consider performing onsite audits. This allows you to verify the accuracy of self-reported data and gain deeper insights into their risk posture through audits. 

6. Incorporate Vendor Risk Scoring in Contract Negotiations

Include vendor risk scores as part of your contract negotiations process. Higher risk vendors might be subject to stricter obligations like frequent audits, tighter security controls, or limited access to sensitive data. 

7. Leverage External Risk Experts

For complex areas like cybersecurity, consider hiring third-party risk experts to perform detailed assessments. These experts can provide in-depth evaluations of vendor risks and help ensure that your risk scoring system remains robust and accurate.  

Who should own third-party risk scoring? 

The responsibility of third-party risk scoring can vary depending on the size of the company, industry, and internal structure. Some companies may have a dedicated vendor risk management team. In others, this can be distributed among multiple departments.

Here are some potential owners of third-party risk scoring based on their roles:

  • Information Security and Cybersecurity Teams: Since vendors often have access to sensitive data, these teams typically evaluate the security posture of third parties.  
  • Procurement and Sourcing Teams: These departments are often the first touchpoint for vendors. They are crucial to evaluate the reliability, stability and alignment of vendors.  
  • Risk and Compliance Teams: They usually are the last word on regulatory requirements and internal standards and therefore play a central role in risk scoring. 
  • Operations and Supply Chain Teams: When it comes to checking vendor resilience and operational risk management, these teams play a key role. 

Frequently Asked Questions on Third-Party Risk Scoring

1. What are the benefits of third-party risk scoring?

Third-party risk scoring offers numerous benefits. These include improved decision-making, protection against financial losses, enhanced vendor accountability, and regulatory compliance. It provides a clear overview of the risks associated with each vendor, enabling your business to take proactive action before issues arise.

2. How can third-party risk scoring be automated?

Automated risk management platforms can streamline the scoring process by collecting vendor data, assessing risk levels, and continuously monitoring changes in real-time. These platforms also provide alerts for any significant changes in vendor’s risk profile so that businesses remain aware of potential threats. 

3. What are the key factors to consider when scoring third-party risks?

The key factors include the vendor’s cybersecurity practices, financial health, compliance with relevant regulations, and overall operational stability. Each of these factors provides critical insights into how a vendor might impact your business. 

4. How often should third-party risk scores be updated?

Risk scores should be updated regularly, especially after significant events like new regulations, vendor financial instability, or data breaches. Using continuous monitoring tools helps businesses keep vendor risk assessments up to date.  

5. What challenges arise when dealing with third-party risk scoring?

Challenges include obtaining accurate and up-to-date data from vendors, managing the complexity of different risk categories, and ensuring that risk scores are updated frequently. Automated risk management platforms can help overcome these challenges.

Need a rough estimate before you go further?

Here's what the average Spendflo user saves annually:
$2 Million
Your potential savings
$600,000
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