Enterprises are becoming more reliant on external vendors to provide goods and services necessary to run their businesses and maintain competitiveness, but reliance on vendors can be a risky proposition, especially with the current economic challenges, according to Gartner, Inc.

"As enterprises increase reliance on vendors for products and services, the more they become exposed to greater risk relating to delivery disruption or vendors' inability to deliver the goods and services for which they are contracted," said Helen Huntley, research vice president at Gartner. "It is crucial for enterprises that use external vendors to understand the risk factors that enable them to judge the exposure they have with each vendor should the vendor go under or face challenges that may lead to delivery disruption."

Ms. Huntley said that vendor risk management is becoming a core competency for organizations, and they should ensure that they have a contingency plan in place to support their business should the worst happen and the vendor supporting their mission critical systems fails them. However, enterprises are advised to categorize vendors before assessing vendor risk, because not all vendors are the same. Some vendors may be categorized as tactical — those that are small in cost and exposure or operate in a commodity environment. Other vendors should be classed as strategic, because the enterprise has a high dependence on them, has high spending, and plans to increase business with the vendor over time.

Gartner has identified four high-level vendor risk criteria areas that enterprises should monitor for any indications that a vendor may be in trouble:

Organizational risk
Organizational risk focuses on changes in personnel within the vendor organization. Changes in staff, especially at senior levels in the organization, can indicate vendor difficulties. The following events can be indicators of potential trouble:

- Management turnover, especially at senior levels in the organization and most notably the CFO

-President, CEO and chairperson of the board are the same individual or are related

-Large layoffs of vendor staff

-Routine rounds of staff reductions

-High employee turnover, and higher-than-normal sales executive turnover

-Senior executives selling off stock

-Significant increase in executives taking on multiple roles as others depart

-No outside board members

-Ties severed with partner firms.

Financial risk
Financial risk is risk associated with any form of financing or financial reporting. The following financial metrics or actions should be monitored for patterns, as no sign on its own is likely to be significant:

- Stock-price-related metrics

-Vendor credit rating

-Restatement of financials by filing a 10-K or other regulatory change form

-Declaration of bankruptcy

-Late filings

-Current ratio, debt-to-equity ratio

-Net income growth rate and cash flow

-Return on equity, return on investment, return on assets

-Cash in bank

-Vendor's inability to obtain financing or negotiate a loan to continue business

-Days sales outstanding.

Support risk
Support risk focuses on the risks that clients face when products or services are no longer supported or delivered to the standards outlined in the contract or set by vendors overall. Things to look for include:

-Layoffs of personnel critical to your business

-Decline in service-level performance and vendor's failure to meet service levels

-Decline in customer service and level of resources, lower skills and lack of support

-Customer turnover

-Product failures, spare shortages and lack of support for products

-Product deficiency.

Strategy risk
Strategy risk is focused on changes to a high-level set of directives that vendors use to articulate how they will achieve their missions. Abrupt changes to strategy could indicate vendor challenges, such as lack of alignment, financial difficulties or an overall weak vision. The following should be followed closely:

-Changes in sales and marketing approach, size and type of deals the vendor is targeting, strategic investments, product strategy, geographic strategy, vertical strategy or industry focus

-Arrival of new competitions that threaten the strategic basis of the vendor's business.

Additional information is available in the Gartner report ‘Vendor Risk Management: Criteria You Can Use to See Whether Your Vendor is in Trouble.’ The report is available on Gartner's website here.

•Date: 12th June 2009• Region: World •Type: Article •Topic: Operational risk
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