The Critical Role of Risk Quantification in Third-Party Risk Management (TPRM)

What's Needed for Calculating Risk Quantification

Risk quantification requires understanding your business's specific financial condition. After all, quantification is ultimately a financial measure, so you'll need to examine corporate budgets and spending to calculate the final number.

For example, procurement professionals know they pay a certain amount of money to suppliers for raw materials necessary for their finished product. A risk quantification exercise would ask: if Supplier X can't provide Y material, then what would the negative impact be on our operations? The answer might be represented in money per day lost from not being able to finish a product and sell it to customers.

Another example is cyber risk. Quantifying the risk of a cybersecurity incident involves calculating the financial impact of downtime and recovery from a third-party data breach or supply chain attack. This is often done with internal systems to advocate for investment in reducing downtime risk, but it can also be translated to the vendor relationship. If a critical technology vendor experiences a cyberattack, you will likely experience the knock-on effects of being unable to do business.

The Role of Risk Quantification in TPRM

Risk quantification simplifies communication of the real financial impact of not addressing critical vendor or supply chain risks. Many third-party risks are frustratingly nebulous in terms of likelihood, and risk scores don't necessarily communicate how a risk could affect the business if it occurs. That's what quantification solves for.

More specifically, risk quantification enables:

1. Objective Risk Assessments -- Risk quantification provides a standardized method for assessing third-party risks. By using consistent metrics and criteria, organizations can objectively evaluate the financial impact associated with each third-party risk. This removes subjectivity and bias, ensuring that risk assessments are fair and comparable across different vendors and service providers.
2. Prioritization of Risks -- Not all risks are created equal. Risk quantification enables organizations to prioritize risks based on their potential financial impact. By assigning a monetary value to each risk, organizations can identify which risks require immediate attention and which can be monitored over time. This prioritization is crucial for efficient resource allocation and effective risk mitigation strategies. This goes beyond risk scoring, which is a measure of likelihood and not a measure of financial impact.
3. Enhanced Decision-Making -- Quantitative risk assessments provide a solid foundation for decision-making. Senior management and risk committees can use the financial impact of risk to make informed decisions about third-party engagements. This data-driven approach ensures that decisions are based on empirical evidence rather than intuition or guesswork.
4. Risk Mitigation and Control -- Once risks are quantified, organizations can develop targeted risk mitigation strategies. For example, if a third party has a high potential financial impact on cybersecurity risk, the organization can implement specific controls to address this risk, such as requiring the third party to adopt certain security standards. Quantified risks allow for tailored risk mitigation plans that are proportional to the risk level.
5. Continuous Monitoring and Reporting -- Risk quantification facilitates ongoing monitoring and reporting of third-party risks. By continuously updating risk impacts based on new information and developments, organizations can track changes in risk levels over time. This dynamic approach ensures that risk management efforts remain relevant and effective as the risk landscape evolves.
6. Regulatory Compliance -- Regulatory bodies are increasingly emphasizing the importance of robust TPRM programs. Quantified risk assessments can demonstrate an organization's commitment to proactive risk management, helping to meet regulatory requirements and avoid penalties. Detailed risk quantification reports provide tangible evidence of compliance efforts.
7. Building Stakeholder Confidence -- Stakeholders, including customers, investors, and partners, are increasingly concerned about third-party risks. A TPRM program that incorporates risk quantification can build confidence among stakeholders by demonstrating that the organization is actively managing and mitigating third-party risks. Transparent reporting on quantified risks and mitigation efforts can enhance stakeholder trust and loyalty.

How Prevalent Can Inform Risk Quantification Efforts

The Prevalent Third-Party Risk Management Platform features extensive capabilities that frame risk likelihood and potential impact in the form of risk scores. The risk scores presented in the Prevalent TPRM Platform serve as the bones for risk quantification with easy-to-understand scoring that indicates which risks TPRM managers should focus on to calculate financial impact. The risk score functionality in Prevalent includes showing the total number of risks based on specific categories and compliance frameworks within the platform.

Figure 1: An example overview of risks based on category, including several compliance standards.

With the Prevalent Platform, third-party risk teams gain important insight into their vendor universe as well as a centralized solution for collaboration and communication with internal and external stakeholders. In this way, risk managers can understand how to best prioritize risk quantification efforts and drive the conversation forward on which identified risks need to be mitigated, and how remediations can impact scores.

Built-in scoring methodology can direct your risk quantification efforts to assign dollar amounts to the most critical risks immediately. Leveraging Prevalent's risk scores as the bones of your risk quantification efforts ensures that you're getting the most accurate insight immediately.

Figure 2: How the Prevalent platform scores risks.

As budgets tighten and supply chains become more complex, it is vital for organizations to calculate the possible financial impact of vendor risks and mitigate the most impactful ones. Risk quantification calculations ensure that can occur, and the scores built into the Prevalent TPRM Platform ensure that you're calculating the financial impact of the most important risks. For more information on how Prevalent can help, request a demo now.