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Third-Party Risk: What You Don’t Know Can Hurt Your Business

Thanks to globalization and advanced technologies, the world economy is increasingly interconnected and a borderless market. Businesses are no longer depending on their own resources and self-developed capabilities in order to achieve operational excellence, fuel growth and drive strategic success.

For example, a retailer headquartered in Toronto, Canada, doesn’t necessarily need to rely on local suppliers to meet its customers demand. A financial services company in London, England can now employ the services of a cyber security expert domiciled in Singapore. Today, businesses are no longer going it alone.

When entering into new lines of business or expanding into new markets, it is common for organizations to leverage third-party knowledge, skills or resources, and form partnerships, alliances, and other business relationships.  These external parties have suppliers, partnerships and alliances of their own too.

Given the interconnection between third-party relationships and the inherent risks, the ability to manage these relationships is critical to success.

Ignorance is no defense

The actions of third-party intermediaries have dire consequences on the business, not just financially but also legally, operationally and reputationally. Moreover, regulators are increasingly policing third-party relationships, and when something goes wrong, the penalties can be hefty.

Think of the U.S Foreign Corruption Practices Act, UK Bribery Act, EU General Data Protection Regulation, or Brazil’s Clean Companies Act. Even if a security breach or risk incident occurs on the other side of the world, entities or individuals found on the wrong side of the law will not escape unpunished.

Activities can be outsourced, but responsibility cant’t. It is therefore imperative that business leaders develop a deeper understanding of third-party relationships including the full spectrum of risks linking in each part of the organization.

You need to adequately examine your clients, vendors, consultants, agents and other business partners, know who they are and how they operate. A basic internet search or third-party website visit doesn’t cut it. A detailed integrity due diligence is required. You need to know your business partners’ qualifications, business history, reputation and their relationship with foreign government officials.

In addition, you also need to understand the business rationale behind including the business partner in the transaction. Failure to do so could expose your organization to reputational damage, operational risk, government inquiry, monetary penalties and even criminal liability. What you don’t know about your business partners can hurt you.

Visibility over third-party business relationships

In a number of organizations, the examination of business relationships and assessment of inherent risks is left in the hands of the procurement function. The function identifies potential savings from outsourcing, the legal team drafts the contract and it’s business as usual. There is no or little follow up on the relationships.

In some cases, external relationships are managed in silos within business units. The business unit that owns the relationship also manages the risk. These individual business units have different ways of tracking their suppliers, vendors or partners, making it difficult to compare and collate them across the entire business. In addition, sometimes there is a duplication of efforts and inconsistent application of risk assessment and management standards.

In other cases, companies adopt a centralized or hybrid approach in order to help overcome the challenges presented by the decentralization model. With the centralized approach, redundancies are reduced, and risk decisions reside with a single group in turn fostering accountability for risk assessment.

However, it is important to note that with this approach tensions can sometimes arise between business units that have a working relationship with the external parties and the centralized team accountable for risk assessments. As a result, some companies pursue a hybrid model in which risk ownership is clearly defined and decision making rights are spread across a number of business functions, such as procurement, finance, compliance and risk management.

As the business is constantly on-boarding or terminating external partnerships and expanding or reducing third-party services, it’s therefore important for business leaders to develop a strategy and road map to systematically identify third parties using an inclusive definition.

For many companies, key data about business relationships resides in multiple procurement systems and in emails, spreadsheets, and text documents. Manually building a complete inventory of current contracts from these multiple sources, and then analyzing and interpreting all the data in order to assess risks and make informed decisions can prove challenging.

New technologies such as robotic process automation and natural language processing can however help obtain visibility over third-party relationships. RPA helps integrate information from disparate sources and systems without manual intervention and embed control mechanisms into an automated process, thus increasing efficiency and streamlining third-party transaction risk management.

On the other hand, natural language processing helps to analyze documents written in plain text and signal critical risks, enabling third-party controls to be automatically reviewed for potential risks emanating from inadequate or unclear contract language.

Strong governance process

Traditionally, risk has been regarded as something to be minimized or avoided, with considerable effort spent on protecting value. However, in today’s global competitive environment, in order to progress and achieve strategic success, a business should develop an appetite for risk taking. A business cannot expect to grow and expand by avoiding risk or hesitating to expand its universe of third-parties.

However, given that today organizations are being held responsible not only for their own actions but also for the actions of customers, suppliers, vendors or partners, it’s critical for company boards to provide oversight to ensure that effective third-party risk management practices are in place.

To avoid confusion, there should be clarification on who owns third-party risk in the organization, including where third-party risk management sits within the organization. It is the board’s responsibility to ensure that management establishes a clear organizational model and process for third-party risk management.

In addition, management should provide a clear line of sight to the organization’s major external-party risks by establishing an effective reporting system and keeping the board informed of how critical risks will be mitigated.

The focus should not only be on achieving cost savings or efficiencies, but also on driving value creation and meeting set objectives of the business. Thus, there should be alignment to the broader strategy of the business.

As the world increasingly becomes digitally interconnected and the extended enterprise grows and gets more complex, third-party risk management should also become a top priority for any business.

Also important to note is that assessing and mitigating third-party risk is an ongoing process. It’s about prevention rather than reaction.

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The Art of Risk Management

This is the title of the article by BCG published a few years ago. The article discusses the principles that should govern the approach to risk management by companies of all shapes and sizes.

The authors make several points with which I agree. Here are some excerpts:

  • Risk management is essential in today’s volatile economy. In a continuously changing economic environment, companies cannot assume a stable risk landscape.
  • Stop thinking of risk management as primarily a regulatory issue. Embed risk management in the mindset of the broader organization.
  • Risk management is a value-creating activity that is an essential part of the strategic conversation inside the company. The goal of that discussion should not be to eliminate or minimize risk but to use it to create a competitive advantage.
  • Risk management starts at the top. The organization needs to demonstrate that it has made risk management a high priority and an integral part of the decision-making process by appointing a dedicated risk leader who reports back frequently to the CEO and the board to discuss the latest trends and any changes in the company’s risk scenarios.
  • Risk cannot be managed from an ivory tower. Risk Management should not exist in isolation from the rest of the organization, with an insufficiently granular understanding of the actual business-specific risks the company faces. To avoid this outcome, integrate risk management into the company’s entire routine management processes, including planning, capital allocation, controlling, and reporting.
    • Understand the scope of the risks the company faces.
    • Plan for how the company will manage those risks.
    • Act to mitigate the risks or take advantage of strategic opportunities.
  • Avoid relying on black boxes. Although sometimes appropriate, over-reliance on complex metrics or models can muddy the risk management process, turning it from a transparent management activity into a frustrating black box. The appropriate level of complexity is company-specific and depends on the industry, business model, availability of data, level of experience, and mandatory legal requirements.
  • Align risk management with a company’s overall business strategy. Companies need to identify all relevant risks – not just those that can be easily quantified. Some of the relevant risks for a company may be those that are qualitative and especially difficult to quantify.
  • Risk management is more than a policy; it is a culture. The objective of a company’s risk-management system should be not only to enforce new policies but also to create a risk-aware culture that addresses risks proactively, not reactively, and manages them to create new sources of competitive advantage.
  • Effective risk management depends on the free flow of information throughout the organization. Unless employees at all levels of the organization are actively involved in the risk management process, it will be difficult to maintain the unrestricted flow of information. This can result in the most important data getting buried in one part of the organization unavailable to other parts of the business.
  • Risk management deals with uncertain futures. As a result, the goal should not be to develop precise metrics or future outcomes but to strive for a general understanding of the probabilities and potential impact of various trends or scenarios on business performance and enable decision-makers to confront the uncertain nature of risk and act accordingly.
  • Risk management is never about finding “the answer.” Rather, it is about continually refining the organization’s assumptions about the future and its understanding of the implications of those assumptions for the company’s business. Assumptions about risk often change quickly, so the relevant parameters, probabilities, impacts, and correlations should be revisited frequently.
  • It is possible to prepare for unknown risks by building an organization that so excels at crisis management that it is resilient even in situations in which it is blindsided by unprecedented challenges. For example, through developing the ability to detect, capture, and exploit information patterns as well as to think outside existing frameworks and risk landscapes.
  • Avoid the downside, but don’t forget the upside. Companies should use risk management also to identify new opportunities and to exploit them systematically. For example, scenario planning should be used to define not only worst-case scenarios but also best-case scenarios. Think in advance about how a company can make the best use of the latest market developments and trends and ultimately make the right decisions.

I enjoyed reading the article and highly recommend it.

Thanks for sharing:

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Leading in Uncertain Times

One of the biggest challenges facing business leaders today is making the right decisions that will ensure their organizations succeed, survive, and remain competitive in an increasingly uncertain and complex environment.

A recent post, The best way to lead in uncertain times may be to throw out the playbook, by Strategy+Business has several good points.

The article is about the COVID-19 pandemic, how global companies navigated through the crisis, and how best to prepare for future disruptions. Here are some key points and my comments.

  • Rather than follow a rigid blueprint, executives must help organizations focus on sensing and responding to unpredictable market conditions.
    • Comment: Senior leaders play a vital role in providing clarity about the organization’s strategic direction, creating alignment on key priorities to ensure the achievement of enterprise objectives, and ensuring the business model is continuously evolving to create and capture value in the face of uncertainty. They must not rest on their laurels and stick to the beliefs and paradigms that got them to where they are today and hope they will carry them through tomorrow. Regulatory changes, new products, competition, markets, technologies, and shifts in customer behavior are upending many outdated assumptions about business success. Thus, the businesses you have today are different from the ones you will need in the future hence the importance of continuously sensing changes in the global economy. Employees and teams often feed off the energy of their leaders and tend to focus their attention where the leader focuses attention. If the leader is comfortable with current business practices and rarely embraces the future or challenges the status quo, then the team is highly likely to follow suit.
  • When it became clear that supply chains and other operations would fracture, organizations began scenario planning to shift production sources, relocate employees, and secure key supplies.
    • Comment: Instead of using scenario planning to anticipate the future and prepare for different outcomes, it seems most of the surveyed organizations used scenario planning as a reactionary tool. Don’t wait for a crisis or a shift in the market to start thinking about the future. The world is always changing. As I wrote in The Resilient Organization, acknowledge that the future is a range of possible outcomes, learn and develop capabilities to map out multiple future scenarios, develop an optimal strategy for each of those scenarios, then continually test the effectiveness of these strategies. This does not necessarily mean that every change in the market will impact your business. Identify early warnings of what might be important and pay closer attention to those signals. In other words, learn to separate the signals from the noise.
  • The pandemic forced the organization’s senior management team to re-examine how all decisions were made.
    • Comment: Bureaucracy has for a very long time stood in the way of innovation and agility. To remain innovative and adapt quickly in a fast-changing world, the organization must have nimble leadership and an empowered workforce where employees at all levels can dream up new ideas and bring them to life. Identifying and acting on emerging threats and potential opportunities is not the job of the leader alone but every team member. To quote Rita McGrath, in her book Seeing Around Corners, she writes, “Being able to detect weak signals that things are changing requires more eyes and ears throughout the organization. The critical information that informs decision-making is often locked in individual brains.” In addition to the internal environment, the leader must also connect with the external environment (customers, competitors, regulators, and other stakeholders), looking for what is changing and how.
  • It’s worthwhile for leaders of any team to absorb the lessons of sense-respond-adapt, even if there is no emergency at hand.
  • Sensing: Treat the far-flung parts of your enterprise as listening stations. The question leaders must ask is, “What are we learning from our interactions beyond the usual information about costs and sales?” Train your people to listen for potentially significant anomalies and ensure that important information is not trapped in organizational silos.
    • Comment: Cost and sales data are lagging indicators that reveal the consequences or outcomes of past activities and decisions. Although this information can help leaders spot trends by looking at patterns over time, it doesn’t help understand the future and inform what needs to be done for the numbers to tell a different story. In addition to lagging indicators, pay attention to current and leading indicators and understand the relationship between these indicators and outcomes.
  • Responding: Improve communication across intra- and inter-organizational boundaries. Leaders should view business continuity as an essential function that acts as connective tissue for the enterprise.
    • Comment: In addition to creating mechanisms that allow the free flow of information both inside and outside the organization, decision-makers should also be comfortable receiving information that challenges their personal view of the world, even if it’s not what they want to hear. Create a culture of psychological safety where people are not afraid to share bad news for fear of getting punished, but rather are acknowledged and rewarded for speaking up. Leveraging the diversity of thought enables leaders to anticipate the future as an organization, decide what to do about it collectively, and then mobilize the organization to do what’s necessary.
  • Adapting: Challenge assumptions, and question orthodoxies. There’s always the temptation to mitigate threats simply by applying existing practices harder and faster. One way to get at those deeper issues and encourage double-loop learning is to ask, “What needs to be true for this to be the right approach?”
    • Comment: In an increasingly uncertain environment, it’s difficult to survive and thrive with an old business model or outdated technologies. Many businesses fail because they continue doing the same thing for too long, and they don’t respond quickly enough and effectively when conditions change. As a leader, stay curious and connected to the external environment, look for market shifts, understand what needs to be regularly refreshed and reimagined, adopt new technologies and capabilities, and adapt in ordinary times but also during times of transition. Unfortunately for many leaders, it’s just more convenient for them to continually downplay the fact that conditions are changing than take the appropriate course of action that drives business success.

How are you preparing your organization for potential future disruptions?

Thanks for sharing:

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The Collaborative Organization

These days the term collaboration has become synonymous with organizational culture, creativity, innovation, increased productivity, and success.

Let’s look at the COVID-19 pandemic as an example. At the peak of the crisis, several companies instructed their workers to adopt remote working as a health and safety precautionary measure.

Two years into the pandemic, they are now asking their employees back to the office full time or are planning to adopt a hybrid model.

The need to preserve our collaborative culture and accelerate innovation are two of the top benefits being cited by organizational and team leaders for bringing workers back.

Collaboration is indeed essential for the achievement of team goals, functional objectives, and the overall success of the organization.

Today’s breakthrough innovations are emerging from many interacting teams and collaborative relationships.

When teams, functions, and organizations collaborate, the whole is greater than the sum of its parts; group genius emerges, and creativity unfolds.

But, what makes a successful collaboration? What are the key enabling conditions?

  • It extends beyond the boundaries of the organization. Business success is a function of internal and external relationships. Instead of viewing your business in vacuo, understand that you are part of an ecosystem. External to your organization, who do you need to partner with to enhance your value creation processes, achieve/exceed your objectives, or successfully execute your strategy?
  • Ensure the objectives are clear and there is shared understanding by everyone. Unclear objectives are one of the topmost barriers to team and organizational performance.
  • Foster a culture that encourages opinions and ideas that challenge the consensus. People should feel free to share their ideas and not hold back for fear of others penalizing them or thinking less of them. Collaboration is hindered when one or two people dominate the discussion, are arrogant, or don’t think they can learn anything from others.
  • Groups perform more effective under certain circumstances, and less effective under others. There is a tendency to fixate on certain topics of discussion amongst groups which often leaves members distracted from their ideas. To reduce the negative effects of topic fixation, members of the group should be given periods to work alone and switch constantly between individual activity and group interaction.
  • Effective collaboration can happen if the people involved come from diverse backgrounds and possess complementary skills to prevent conformity. The best collective decisions or creative ideas are often a product of different bodies of knowledge, multiple opinions, disagreement, and divergent thought processes, not consensus or compromise.
  • New technologies are making collaboration easier than ever, enabling us to increase our reach and broaden our network. Although new technology helps, it will not make your organization collaborative without the right culture and values in place. First, define what you want to achieve through collaboration then use these tools to promote creative collaboration.

How else are you championing collaboration within your organization to create value and succeed?

Thanks for sharing:

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