Risks & Volatility Persist for High-Tech Firms

The disasters of 2011 -- specifically the floods in Thailand as well as the earthquake and subsequent tsunami and nuclear contamination in Fukushima, Japan -- have led major tech companies to look into better ways to insure against risk in their supply chains. At least, I hope so.

But those are the micro events: isolated, once-in-a-lifetime disasters in specific locations. There's no way to predict exactly where and when such events will occur. That's why insurers look at the long-term, macro trends like population density and climate change. And it's why forward-looking tech companies will start paying attention to these trends as well, and take them into account in their overall supply chain planning.

Last October, the world's population reached an astounding seven billion people. Even more astounding is the fact that, unless fertility rates drop, it will reach eight billion by 2024 and nine billion by 2042, according to The Population Institute. Much of that growth will be in developing nations, particularly in China. In China alone, an estimated 320 million people are expected to migrate from rural areas to cities over the next decade and a half, according to an upcoming book, The Urban Billion by Tom Miller, an editor at the China Economic Quarterly.

Major contract manufacturers are located in Chinese high-growth areas, usually on the coasts so they can easily access the major shipping ports. The largest factory of Foxconn Electronics Inc. , for example, is in Shenzhen, which surpassed 10 million people in 2010 and is considered one of the fastest growing cities in the world. The increased urban density is creating new risks and increasing existing ones. Some of the concerns include:

• Weather: Climate change is causing a rise in sea levels, making coastal areas even more vulnerable to tropical storms and flooding.
• More people, buildings, and equipment in disasters' paths: Because more people and facilities are concentrated in smaller areas, any one disaster -- like an earthquake or flood -- has a greater potential to create much greater damage and higher losses.
• Stress on infrastructure and environment: The rapid migration of people and businesses to these urban centers is creating more infrastructure and environmental stresses. This not only weakens the local government's ability to keep up with increased demands for food, water, energy, and transportation, but also leaves the government with fewer resources to prepare for and protect against the impacts of natural disasters.

Chinese cities are already struggling with these trends. Urbanization means more land is paved over and the ability for the ground to absorb water is more limited, producing more runoff going to rivers, which leads to more flooding. In 2008, rivers in South China were unable to handle unusually heavy rains, leading to major flooding that killed hundreds and required the evacuation of more than one million people. (An academic paper on the Shenzhen region explains how urbanization can increase flooding.)

Shanghai, located in China's Yangtze River Delta, has already spent more than $6 billion on flood control infrastructure, including levees and dikes, to protect against rising sea water levels and potential floods, according to Scientific American. But on the whole, most of the world is not spending enough to maintain and upgrade their infrastructures. Globally, infrastructure requirements are estimated at more than $50 trillion over the next 25 years, according to Ernst & Young International .

Major insurers and re-insurers are paying a lot of attention to these mega-trends. They are running models of potential natural and man-made catastrophes on these increasingly dense urban areas, creating updated actuarial tables that will translate to higher insurance costs. As tech executives prepare strategic plans for evolving their supply chains and mitigating their risks, they ignore these trends at their peril.

But how can the industry accurately assess the risks? That's a topic for another post, coming next week.