How to Build a Vendor Risk Management Strategy That Protects Your Business

If your business depends on vendors for goods or services, you cannot afford to ignore vendor risk management.

Data breaches, regulatory violations, and vendor financial instability can lead to operational disruption, costly penalties, and reputational damage.

Understanding and implementing vendor risk management will help your business avoid unacceptable risks and protect its reputation.  

What is Vendor Risk Management?

Vendor risk management (VRM) is a continuous due diligence process implemented before and after purchasing from or outsourcing to third-party suppliers. 

Vendor risk management reduces the risks of poor data security controls, cybersecurity failures, regulatory violations, and business disruption from supplier failure or significant supply chain delivery delays.

Common Types of Vendor Risk

While there are many types of vendor risks, operational and financial risks are the top considerations for business risk managers, according to the 2025 EY Global Third-Party Risk Management Survey.

Here’s a closer look at some of these risks:

1. Operational Risk

Operational risk is a top concern for businesses working with third-party vendors. Any disruption to a vendor’s operations can significantly affect your business’s operations.

2. Financial Risk

Obtaining cost savings is the primary reason companies outsource, but if a supplier experiences financial instability or a poor credit history, they may not be able to meet contract terms.

This can lead to higher costs and affect your business operations. 

3. Cybersecurity Risk

Third-party cybersecurity issues, such as unauthorized access, hacking, and malicious attacks, can have a ripple effect on businesses that rely on these vendors’ products. 

For instance, when SolarWinds, a software company, was targeted by cyberattacks in 2020, hundreds of organizations that relied on its software to optimize their networks suffered data breaches.

4. Ethical Risk

A vendor’s involvement in illegal or unethical practices, such as child labor, can negatively affect your company and damage your brand.  

5. Environmental Risk

A vendor with a high carbon footprint or a supplier who uses hazardous materials negatively impacts the environment.

Having a supplier involved with this risk can lead to bad publicity and damage your company’s reputation. Plus, your company also indirectly contributes to environmental pollution.  

6. Political and Economic Risks

The vendor’s country’s political and economic instability can affect its ability to meet your company’s needs. It can also affect the price of its products or services. 

For example, the supplier’s country may have an unstable currency, making it difficult to predict the cost of goods over time. 

7. Fourth-Party Risk

Fourth-party risk arises when your vendors maintain relationships with third parties, such as service providers, suppliers, and business partners. 

These risks are harder to detect in a complex vendor ecosystem, as a business may not even be aware of them until its vendor discloses them. 

However, you can still be held accountable for data breaches or business disruptions caused by fourth- or nth-party vulnerabilities.  

Why is Vendor Risk Management Important?

According to Gartner, compliance leaders consider up to 40% of their third parties to be in the high-risk category. That’s a considerable quantum of risk for businesses that work with hundreds to thousands of vendors worldwide.

As you saw in the previous section, these risks can arise when working with vendors listed on the OFAC sanctions list, those that are fraudulent, those that violate ethical standards, or those that are vulnerable to cybersecurity threats.

Without robust vendor risk management protocols, these vulnerabilities can lead to devastating consequences.

Here are some of the main reasons why third-party risk management (TPRM) is important:

1) To protect the organization from financial losses

Third-party vulnerabilities can lead to data breaches, penalties, business disruption, and loss of customer trust, resulting in financial losses.

For example, the average cost of a data breach arising from third-party vendor compromise is $4.91 million.

Vendor risk management best practices can help prevent financial losses by implementing a plan to address disruptions and ensure business continuity.

2) To maintain compliance with regulations

Your organization may be at risk of noncompliance if a vendor fails to meet its regulatory obligations. 

For example, if a vendor violates OFAC sanctions, your organization may also be held liable and face multimillion-dollar penalties.

With a robust vendor risk management protocol, you can ensure you work only with vendors that comply with required regulations by verifying their backgrounds.

3) To safeguard the organization’s reputation

An organization’s reputation can be severely damaged if associated with a vendor with ethical or other issues. For example, if a company uses child labor in its supply chain, the news will quickly spread, and customers may start boycotting its products and those of its associated brands.

However, having supply chain risk management in place can help you be one step ahead and take necessary precautions to avoid such vendor risk disasters.

4) To ensure the continuity of operations

In some cases, supply chain disruptions can lead to a complete shutdown of operations. This is especially true for companies that rely on just-in-time delivery of materials. 

A plan that expects disruptions from vendors and suppliers can help ensure operations can continue.

Vendor Risk Management Framework: Key Components

The key components of vendor risk management include vendor risk assessment, risk mitigation, continuous monitoring, and lifecycle management.

Vendor Risk Assessment

Before designing a VRM program, it is important to accurately identify and assess vendor risks.

Here are the steps to follow to assess vendor risks.

Risk Mitigation

After identifying and assessing risk factors, you can develop internal policies and methodologies to mitigate risk, gain a competitive advantage, and minimize stockouts and downtime. 

The goal here is to prioritize risks, reduce the likelihood of disruption, and minimize the impact if one does occur. 

There are many ways to do this, but some common approaches include:

Diversification

One way to reduce supplier risk is to spread it out by working with multiple suppliers for the same product or service. This way, if one supplier has a problem, you can switch to a new vendor.

Redundancy

Another approach is to have redundant systems in place so that if one supplier has a problem, you can quickly switch to another. 

For example, if your business relies on a single supplier for parts and there are alternatives, you might keep a stock of raw materials from other suppliers on hand to continue production in the event of a disruption.

Contracts

Another way to reduce supplier risk is to include clauses in vendor contracts that protect you in case of a problem. For example, you might require the supplier to provide replacement parts at no cost if they experience a production stoppage.

Business continuity plan

Having a business continuity plan ensures your operations are not disrupted by third-party risks, such as security failures, bankruptcies, or political instability.

Strategies to improve third-party relationships are an important component of a business continuity plan. 

For instance, manufacturing and wholesale distribution solutions used over time can help optimize supplier satisfaction, increasing the likelihood of obtaining the needed parts in the event of a supply chain disruption.

Continuous Monitoring

Continuously monitoring ensures vendors continue to meet the quality, security, and regulatory requirements of your business. 

Some of the parameters to track include: 

• Security certifications and internal controls
• Updated financial statements and credit scores
• Regulatory compliance
• Service disruptions
• SLA performance

Based on these ongoing evaluations, you may need to update the vendor risk matrix.

Lifecycle Management

Vendor lifecycle management ensures that the vendor’s security posture and other risks are identified, assessed, monitored, and mitigated at every stage of the relationship, from initial evaluation to offboarding.

By embedding proactive controls throughout the lifecycle, businesses can optimize vendor relationships, minimize risks, and ensure adherence to SLA (service level agreement) targets.

Lifecycle management involves:

• Initial evaluation of potential vendors
• Risk assessment and reassessments
• Selection and onboarding
• Performance management
• Supplier relationship management

How to Implement Vendor Risk Management

Here are the vendor risk management implementation best practices to follow:  

Establish a Company Policy for Vendor Risk Management

The company policy on vendor risk management should include: 

• Vendor selection criteria, including risk assessment procedures and risk scores
• Vetting procedures (onboarding process, verification of TIN and other details)
• The vendors or suppliers to choose from for sourcing each type of item
• Policies related to ESG, ethical sourcing, and responsible supply chain practices
• Business continuity and incident response plans

Get Vendor Recommendations from their Customers

As part of the vetting process, get recommendations from the potential supplier’s customers.

Obtain Credit Report Information and Vendor Financial Statements 

To prevent dealing with vendors that could be put on credit hold by their suppliers or go out of business, choose financially healthy vendors. 

Subscribe to a credit report information service like Dun & Bradstreet. Choosing an unstable vendor may result in prolonged delivery delays, customer relations risks, and financial impacts on your business. 

Use a Vendor Risk Management and Control Matrix to Evaluate Vendors 

A vendor risk management matrix is a valuable tool in your vendor risk management framework.

With a vendor risk management and control matrix, your business can calculate current risk estimates and the probability of occurrence, assign a risk score, and determine any action steps required to mitigate unacceptable vendor risk. 

Perform a vendor risk matrix evaluation before vendor selection. Update the vendor risk matrix regularly

While every business differs in terms of risk categorization and metrics, here’s a sample risk matrix for a vendor based in Canada:

Have the Selected Vendors Sign a Service-Level Agreement 

As a tool in your vendor risk management program, a signed service-level agreement will help you achieve better vendor performance or, otherwise, receive compensation in the form of “remedies or penalties.” 

SLAs may improve vendor relationships by helping vendors understand your well-defined expectations from the beginning.

Onboard Suppliers Upfront upon Selection

Get the required tax compliance forms from vendors electronically. Validate vendors by screening them against tax lists. 

Utilize a vendor self-service portal for seamless onboarding.

Perform Ongoing Vendor Due Diligence 

Vendor risk management requires continuous monitoring of risk exposure. Throughout the vendor lifecycle, continue to review your suppliers for potential risks to your business. 

You may use a combination of questionnaires and automated, real-time screening in your vendor risk management process.

In larger companies, you may want to conduct internal audits as part of your supplier risk assessment to ensure adequate controls are in place. 

Apply the NIST Cybersecurity Framework to Vendor Risk Management

The National Institute of Standards and Technology created 5 NIST standards for cybersecurity: 

1. Identify
2. Protect
3. Detect
4. Respond
5. Recover

NIST is part of the U.S. Department of Commerce. These industry standards apply to cybersecurity threats that include vendors and their fourth-party relationships. 

Utilize Vendor Risk Management Software

Automation software is an integral part of your third-party risk management solution as it can help with vendor risk mitigation and remediation. 

Sophisticated software also streamlines procurement, vendor payments, and other business process workflows, saving time and effort.

How Finance and AP Controls Strengthen Vendor Risk Management

Vendor risk management spans procurement, compliance, IT, and finance. While procurement may lead initial due diligence, finance teams play a critical role in enforcing ongoing controls. Particularly around onboarding, payments, compliance validation, and fraud prevention.

Accounts payable workflows are often where vendor risk becomes operational. Manual onboarding, disconnected compliance checks, and fragmented approval processes increase the likelihood of fraud, payment errors, and regulatory violations.

Modern AP automation platforms help reduce these risks by:

• Automating vendor onboarding and documentation collection
• Validating tax IDs and screening against global watchlists
• Enforcing approval workflows and segregation of duties
• Centralizing vendor data and audit trails
• Integrating with ERP systems for reconciliation and visibility

By embedding these controls into day-to-day finance operations, organizations can strengthen oversight while reducing manual effort.

One example is Tipalti’s AP automation platform, which includes built-in vendor risk management capabilities such as:

• Built-in financial compliance: Automated payee validation and screening for fraud and global regulations (including AML, OFAC, terrorism lists, and tax information matching)  
• Seamless vendor onboarding: Integrated self-service portal for supplier onboarding, including tax compliance documents like W-9 forms, vendor-customer communications, and centralized contract and document storage. 
• Dynamic approval routing: Automated approval routing streamlines invoice and vendor payment processes
• Global mass payment automation: A global payment platform with built-in fraud prevention fast-tracks vendor payments.
• ERP integration: Integration with ERP or accounting software to streamline payment reconciliation
• Optimum controls: Enterprise-grade security and granular access controls to protect data

The value lies in replacing fragmented manual processes with embedded financial controls that improve visibility, compliance, and operational resilience.

Read ADU’s full customer success story.

With Tipalti, ADU increased invoice processing volume from 800 to 1,500 per month, boosted productivity by 88%, reduced AP workload by 25%, and accelerated month-end close by 40%.

Automate and Simplify Vendor Risk Management 

Vendor risk management is an essential part of your governance, risk, and compliance (GRC) program. 

Implement a comprehensive supplier risk management policy that aligns with your enterprise risk management strategy to reduce cybersecurity, data privacy (including HIPAA healthcare and GDPR information privacy), financial, and reputational risks.

Choosing the right software that automates vendor risk management tasks in real time will help you exclude high-risk vendors and perform ongoing due diligence.

To see how centralized supplier onboarding, compliance screening, and ongoing vendor governance can strengthen your risk framework, explore Tipalti’s Supplier Management solution.