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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 {complink 2125|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 {complink 7147|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.

12 comments on “Risks & Volatility Persist for High-Tech Firms

  1. Anand
    July 12, 2012

     In China alone, an estimated 320 million people are expected to  migrate from rural areas to cities over the next decade and a half

    @Tam, thanks for the post. I think all these problems which are created because of overcrowding of the cities can be solved by rapidly developing Tier-2 cities. Governments should try to diversify the development of infrastructure so that it helps the people who are outside megacities. 

  2. Ariella
    July 12, 2012

    It makes sense that insurance companies are the ones looking into this. After all, they're the ones who have to pay out in such situations, and so they need to know the extent of their risk.

  3. bolaji ojo
    July 12, 2012

    The companies have to be in the driver's seat of this, however. They probably know their exposure better and would be able to help the insurers determine coverage.

  4. Anna Young
    July 12, 2012

    It's difficult for companies to separate themselves from the challenges facing the host communities. In some cases, those challenges become part of the business issues companies encounter and must deal with, for instance natural disasters.

  5. Barbara Jorgensen
    July 12, 2012

    I find this topic fascinating, mostly because I'm unclear how supply chain insurance wroks. I get that you can cover financial losses associated with disasters, but how are things like liability, missed orders etc. handled? I'm sure they are included in contracts, but there are so many layers to this. I'm looking forward to the next blog

  6. mfbertozzi
    July 13, 2012

    I was thinking till a recent past, it happens companies, in making costs' cut, have tried to avoid these kinds of expenses; (imo) they have understimated the crucial role of adequate investments for risks' protection. It is good to know, things are moving toward right direction, is it a global trend or does it depend from country to country?

  7. FLYINGSCOT
    July 13, 2012

    I wonder how many companies are in the business of advising other companies on the merits of setting up in particular geographic locations.  Seems like this is a growth area too.

  8. bolaji ojo
    July 13, 2012

    @mfbertozzi, Nothing in business is local anymore. Even companies that think they sell only locally might be surprised where their products end up. They also buy parts, applications and equipment made in other parts of the world. All business is now both local and global and the same applies to risk management. All companies keep an eye on events locally and globally.

  9. bolaji ojo
    July 13, 2012

    @mfbertozzi, Nothing in business is local anymore. Even companies that think they sell only locally might be surprised where their products end up. They also buy parts, applications and equipment made in other parts of the world. All business is now both local and global and the same applies to risk management. All companies keep an eye on events locally and globally.

  10. mfbertozzi
    July 13, 2012

    @Bolaji: that's right, I'm also convinced thinking global is an asset for the market and for getting back on track the business, but general feeling seems it is still a dream; ACTA debate without a common and shared global view is an example, maybe it takes time, after all, I am positive.

  11. Eldredge
    July 15, 2012

    @Barbara – It would also be interesting to know if insurance companies require implementation and review of disater recovery plans in order to mitigate their risks.

  12. Barbara Jorgensen
    July 16, 2012

    @eldrege: There are many things about this that make it so interesting, particularly how you make good, if at all, on your promise to your customer. Also, is there an “act of god” clause?

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