Third-Party Risk Assessment Guide and Best Practices

You rely on third-party vendors to boost efficiency, but with this reliance comes the necessity of a comprehensive third-party risk assessment to avoid significant risks. Did you know that nearly 60% of data breaches in large companies involve third parties? This highlights just how vulnerable your business is to external threats. The data breach cost has risen to $4.88 million, a 10% increase from the previous year. What’s worse, many businesses take over 100 days to recover from these breaches.

With the rise in data privacy and cybersecurity laws and increasing third-party risks, especially with subcontractors adding new vulnerabilities, you need to do more than just conduct an initial risk assessment. Third-party risk management should be an ongoing process. It’s not something you can set and forget.

This guide will assess, manage, and reduce third-party risks using clear strategies and best practices. We’ll help you protect your business from threats and ensure you stay secure, compliant, and resilient.

What Is Third-Party Risk Assessment?

Third-party risk assessment evaluates the potential risks posed by external vendors, partners, or contractors. These risks could range from cybersecurity vulnerabilities to financial instability and have severe consequences if not appropriately addressed. By assessing these third-party relationships, you can safeguard your operations, data, and reputation while complying with industry regulations.

Why Is Third-Party Risk Assessment Important?

A proper third-party risk assessment is essential for maintaining trust, transparency, and compliance in today's interconnected business world. The risks posed by third parties can have widespread effects, impacting everything from business operations to customer trust. Here are some key reasons why third-party risk assessment is important:

Key points to consider:

• Regulatory Compliance: Many industries require a third-party risk assessment to ensure vendors are compliant with industry regulations such as GDPR, HIPAA, and PCI DSS
• Reputation Protection: A third party’s actions can damage your reputation even if they don’t directly involve your company. This is especially pivotal for industries where trust and security are paramount.
• Operational Continuity: Third-party failures can disrupt your business. By assessing their risk profile, you can minimize potential interruptions. In 2024, the industrial sector saw the highest data breach cost increase, averaging $830,000 per breach, illustrating the impact of third-party incidents.
• Cybersecurity: Vendors handling sensitive data, IT services, or critical systems can weakly link your security infrastructure. Weaknesses in their security practices can lead to data breaches, ransomware attacks, or other serious threats.

Failing to conduct third-party risk assessments can jeopardize your company’s operations, reputation, and long-term success. Now that we’ve covered the importance of third-party risk assessments, let’s explore the types of third-party risks.

Types of Third-Party Risks

Third-party risks can manifest in various forms, each with the potential to impact your business differently. Recognizing and understanding these risks is essential for effective management, and it’s important to be aware of the key types that could affect your operations and security. Here are the main types to consider:

• Cybersecurity Risks: This involves potential vulnerabilities due to third-party vendors who handle sensitive data or manage critical IT systems. If their security protocols are weak, it can lead to data breaches, ransomware attacks, or malware infections.
• Compliance Risks: These arise when third-party vendors fail to comply with industry regulations, such as GDPR, HIPAA, or PCI DSS. Non-compliance can lead to fines, reputational damage, and legal consequences for your business.
• Operational Risks: These are related to supply chain disruptions, service delivery delays, or vendor performance failures. A vendor’s operational inefficiencies can directly affect your business operations and cause interruptions or delays.
• Financial Risks: If a vendor faces financial instability or insolvency, it can disrupt your business relationship. These risks are particularly critical when third parties manage key financial or transactional operations.
• Reputational Risks: Actions or failures by a third party can damage your brand’s image and trust with customers. A vendor's failure to meet standards can harm your reputation even if your business isn't directly involved.

Strategic Risks: These risks emerge when your third-party partners' goals, values, or strategic directions diverge from yours. Conflicts in business strategy can create challenges in collaboration or misalignment with your long-term objectives.

Next, explore some best practices businesses should follow to manage third-party risks.

Protect your business with Fraxtional’s third-party risk management services. Learn more!

Best Practices for Managing Third-Party Risk

Managing third-party risks goes beyond simply conducting an assessment. It involves implementing ongoing processes to help you handle these risks as they evolve. Implementing best practices ensures your business remains protected, compliant, and maintains solid relationships with your external partners. Here are the best practices you should follow:

1. Establish Clear Vendor Management Policies

Creating a well-defined vendor management policy is essential for managing third-party risks. By outlining clear guidelines for vendor selection, engagement, and ongoing monitoring, you ensure that all vendors are evaluated using the same criteria. Your policy should include risk assessment procedures, vendor selection criteria, and methods for ongoing evaluation to ensure that third parties remain compliant and aligned with your business goals. Clear policies provide consistency and help reduce unexpected vulnerabilities in your risk management efforts.

2. Perform Regular Risk Assessments

Regular risk assessments are vital for managing third-party risks. By revisiting evaluations frequently, businesses can prevent potential issues from changes in a vendor’s operations, market conditions, or regulatory compliance. These evaluations should consider a vendor’s financial health, security measures, and past compliance. Regular assessments help you identify emerging risks early and adjust risk management strategies accordingly. As of April 2024, the IRS conducted 47 rapid assessments and 153 detailed evaluations of critical vendors as part of its Supply Chain Risk Management strategy launched in October 2023.

3. Conduct Third-Party Audits

Third-party audits are essential for confirming that your vendors meet the standards outlined in contracts and regulatory frameworks. These independent evaluations ensure that your vendors comply with security protocols, data protection regulations, and other operational requirements. Regular audits provide an unbiased view of a vendor's performance, helping you identify areas where they may fall short or where risks are growing. This is particularly valuable in highly regulated industries such as finance and healthcare.

4. Building Cross-Department Collaboration

Managing third-party risks requires a collaborative approach. It’s important to involve IT, legal, finance, and operations departments. IT teams can assess cybersecurity risks, legal teams can evaluate contracts and compliance issues, while finance teams can monitor financial stability. By working together, you can create a more comprehensive risk profile for each vendor and ensure you effectively manage all aspects of a third-party relationship.

5. Create a Contingency Plan for Vendor Disruptions

A contingency plan is essential for ensuring that businesses can respond swiftly to any disruptions caused by a third-party vendor. Whether your vendor faces financial difficulties, security breaches, or other operational failures, having a clear and structured response plan minimizes potential damage. The contingency plan should outline procedures for switching vendors, addressing legal concerns, and informing stakeholders. Thus, your business can maintain operational continuity and avoid lengthy downtimes by planning for potential disruptions.

6. Implement Continuous Monitoring of Third-Party Relationships

Continuous monitoring is vital for maintaining a proactive approach to third-party risk management. Using real-time monitoring systems and automated tools, you can track vendor performance and detect risks as they arise. Continuous monitoring allows you to respond swiftly to changes in financial stability, data security, or compliance status, helping you stay ahead of emerging risks. This ongoing vigilance ensures that your third-party relationships remain secure and compliant.

Following these practices will help your business manage third-party risks while ensuring that your relationships with external vendors remain productive and secure. However, companies still face common challenges during third-party risk assessments even with these practices in place. Let’s discuss some of these challenges and how to overcome them.

Read: How to Create an Effective Compliance Program: Key Steps & Best Practices

Common Challenges in Third-Party Risk Assessment

Assessing third-party risks isn’t always easy. Several challenges can hinder the effectiveness of your risk assessment process. These challenges often stem from a lack of visibility, resource constraints, or the complexity of vendor relationships. Here are some common obstacles you may face:

Challenges include:

• Lack of Transparency: Some third parties may be unwilling or unable to provide the necessary information for a thorough risk assessment. This can create gaps in your understanding of their risks, making it harder to manage potential threats effectively.
• Limited Resources: If you have limited resources, conducting in-depth assessments or maintaining continuous monitoring may be challenging. Smaller businesses may find it especially difficult to assess every potential risk, leaving them vulnerable.
• Complex Vendor Relationships: Many third-party vendors have complex supply chains and subcontractors, making risk assessment challenging due to limited visibility into their operations. A 2025 Department of Defense report highlighted that only 6% of companies have complete visibility across their supply chains, and 84% lack visibility beyond Tier 1 suppliers, heightening vulnerability to disruptions.
• Changing Risk Landscape: Vendors' risk profiles can change as they evolve. A previously low-risk vendor might become high-risk due to financial instability or regulatory changes. In 2025, over 60 U.S. state legislative sessions proposed bills that could restrict responsible financial practices. These regulations may hinder sound decision-making and threaten economic growth, affecting vendors' stability and risk profiles.

These challenges are real but can be overcome through careful planning, resource allocation, and strategic vendor management. With the right tools, your business can keep these challenges in check. Let’s now discuss how companies can ensure ongoing third-party risk reduction through continuous monitoring and proactive measures.

How Fraxtional Can Help You Manage Third-Party Risk Effectively?

Managing third-party risks is no simple task; without the right expertise, the process can quickly become overwhelming. That's where Fraxtional comes in. Fraxtional is a trusted partner for businesses across various industries, offering on-demand fractional risk and compliance leadership to ensure that your third-party relationships are secure, compliant, and aligned with your business goals.

• Fractional Risk and Compliance Leadership: Gain access to experienced professionals like Chief Compliance Officers (CCOs) and Chief Risk Officers (CROs) without the cost of full-time hires.
• Tailored Third-Party Risk Assessments: We help you assess and evaluate the risks posed by your vendors, ensuring compliance with industry regulations and internal standards.
• Ongoing Monitoring and Audits: Fraxtional supports continuous vendor performance, audits, and compliance monitoring to ensure long-term security and adherence to contractual agreements.
• Custom Risk Management Frameworks: Get personalized strategies for managing third-party risks, from vendor due diligence to creating contingency plans for disruptions.
• Regulatory Compliance: Stay ahead of complex regulatory requirements, ensuring your third-party relationships meet industry-specific standards like AML, data privacy, and cybersecurity.

Let Fraxtional Empower Your Business with Secure Third-Party Relationships

With Fraxtional's expertise and tailored solutions, you can confidently manage third-party risks, build stronger relationships with your vendors, and ensure that your business complies with regulatory requirements. Let us handle the complexities of third-party risk management while you focus on growing your business.

Partner with Fraxtional for reliable assessments, ongoing monitoring, and solutions that secure your operations. Get started today!

FAQs

1. How can I identify potential third-party risks in my business? 

Conduct a thorough risk assessment to identify third-party risks, including evaluating the vendor's financial stability, reputation, and compliance history. Ensure you check their security practices, data handling protocols, and adherence to relevant industry regulations. It’s also vital to assess subcontractors or partners they may work with, as they can introduce additional risks.

2. What are the main challenges in third-party risk management? 

The primary challenges include vendors' lack of transparency, limited resources for conducting comprehensive assessments, and complex vendor relationships that make tracking risks across all supply chain levels difficult. Changes in a vendor’s risk profile, such as financial instability or regulatory shifts, can complicate ongoing risk management.

3. How often should third-party risk assessments be conducted? 

Third-party risk assessments should not be a one-time event. Regular assessments should be conducted to ensure that any changes in vendor operations, market conditions, or compliance requirements are quickly addressed. Continuous monitoring of vendors is essential to stay ahead of emerging risks.