The best place to stop a snowball from rolling the wrong way is the top of the hill.
When it comes to managing risk in business, there are two fundamental principles:
- You can’t disarm all of the land mines. A risk is like a land mine – it will detonate sooner or later once the right factors occur. Part of risk management is having enough information to know (or make an educated guess) at which risk “land mines” are more likely to go off than others, so you can stack rank and disarm the land mines in the right order. That way, hopefully you’ll disarm each one in time, and if one does goes off before you can disarm it it will cause minimal damage.
- You don’t have to stop every factor from occurring; you have to stop at least one factor from occurring. If a risk “land mine” detonates, a number of things all went wrong at the same time. Think of it as the lock on Pandora’s Box – for the lock to open (the land mine going off), the pins in the cylinder (the environmental factors) must align perfectly with the key (the catalyst). As long as one of the pins are misaligned, the lock won’t open. If you don’t have the resources or ability to ensure all pins are misaligned, try to ensure at least one pin is misaligned so the land mine can’t go off. (If more than one is misaligned, that’s even better.)
To manage a risk, a business must first mitigate and shift the risk to reduce the chance of the land mine detonating to the greatest extent possible, and then accept or rejectthe residual risk to the business. (For more on this, please see my earlier LinkedIn article on Revisiting Risk Management).
When it comes to your relationships with your key vendors, suppliers and other partners/providers, risk management principles should be applied to both existing partners/providers, prospective partners/providers, and “inherited” partners/providers (e.g., through acquisition). There are a number of ways to mitigate and shift risk in these relationships:
Mitigating the Risks
- Don’t automatically disqualify companies that have had past problems. If an RFP reveals that a partner/provider has had a past issue, focus on what steps they have taken to remediate the issue and protect against a recurrence. The result may be that they have a more robust security and risk management program than their peers.
- Set online alerts, such as Google Alerts, to stay up-to-date on the news relating to your prospective or current partner/provider during the course of your negotiations and relationship, and escalate any alerts appropriately. If the partner/provider is public, set an alert for any spikes (up or down) in stock price.
- Plan for the inevitable. Inevitably, your business relationship will end at some point. It could end when you’re ready for and expecting it, but you can’t count on that. If your partner/provider is mission-critical, develop an “expected” and “unexpected” transition plan and confirm that the partner/provider can locate and provide you the data you need to execute on that plan. For example, ensure you have all information and data you may need if the partner/provider ceases operations (for example, routinely download reports and data sets from their portal, or set up an automated feed). Alternatively, consider ways to ensure that if a partner/provider creates and stores mission-critical information (e.g., order or personal information, critical reports or data, etc.), it’s mirrored securely to a location in your control on a regular basis so that if there’s a problem, you have a secure and current data set to work from. This may be required or important under your company’s business continuity plan, and your contractual commitments to your clients.
- Know your alternatives. Keep abreast of alternative partners/providers, do initial vetting from a security perspective, and maintain relationships with them. If a problem occurs, the company may have to switch partners/providers quickly. If you have taken the time to cultivate a “rainy day” relationship, that partner/provider may be happy to go out of their way to help you onboard quickly should a problem with your existing partner/provider occur (in the hopes that your company may reward their help with a long-term relationship).
- Put contractual provisions in place. Sales and Procurement should partner with IT and Legal to ensure that the right risk mitigation provisions are included in partner/provider agreements on an as-needed basis. Consider adding a standard privacy and security addendum to your agreements, whether on their paper or yours. Common provisions to consider include a security safeguards requirement; obligation to protect your network credentials in their possession; obligation to provide security awareness training (including anti-phishing) to their employees (consider asking for the right to test their employees with manufactured phishing emails, or getting an obligation that they will do so); requiring partners/providers to maintain industry standard certifications such as ISO 27001 certification, PCI certification, SOC 2 Type 2 obligations, etc.; obligation to encrypt sensitive personal information in their possession; obligations to carry insurance covering certain types of risks (ensure your company is named as an additional insured, and try to obtain a waiver of the right of subrogation); rights to perform penetration testing (or an obligation for them to do so); a obligation to comply with all applicable laws, rules and regulations); an obligation to complete an information security questionnaire and participate in an audit; language addressing what happens in the event of a security breach; and termination rights in the event the partner is not living up to their obligations. Not all of these provisions make sense for every partner/provider. Another approach to consider is to add appropriate provisions to a supplier/vendor code of conduct incorporated by reference into your partner/provider agreements (ensure conflicts are resolved in favor of the code of conduct).
Shifting the Risks
- Use contractual indemnities. An indemnity is a contractual risk-shifting term through which one party agrees to bear the costs and expenses arising from, resulting from or related to certain claims or losses suffered by another party. Consider whether to include in your partner/provider agreement an indemnity obligation for breaches of representations/warranties/covenants, breach of material obligations, breach of confidentiality/security, etc. Consider whether to ask for a first party indemnity (essentially insurance, much harder to get) vs. a third party indemnity (insulation from third party lawsuits). Remember that an indemnity is only as good as the company standing behind it. Also, pay close attention to the limitation of liability and disclaimer of warranties/damages clauses in the agreement to ensure they are broad enough for your company.
- Request a Parental Guaranty. If the contracting party isn’t fully capitalized, or is the subsidiary of a larger “deep pocketed” organization, consider requesting a performance and payment/indemnification guaranty to ensure you can pursue the parent if the subsidiary you are contracting with fails to comply with its contractual obligations.
- Acquire insurance. Finally, consider whether your existing or other available insurance coverage would protect you against certain risks arising from your partner/provider relationships. Review the biggest risks faced by your company (including risks impacting your partner/provider agreements) on a regular basis to determine if changes to your insurance coverage profile are warranted; your coverage should evolve as your business evolves. Understand what exclusions apply to your insurance, and consider asking your broker walk you through your coverage on an annual basis.