Guide to Incoterms
If you are new to the processes involved in commercial freight shipping, especially international freight, you can be forgiven for any lack of knowledge about incoterms rules.
However, whether you will be the purchaser or the seller in an international trade relationship, you will need to understand what incoterms are, the roles they will play in your shipping activity, and how to use them.
This guide will provide you with the incoterms-basics you need to get started with any global shipping operation. After reading it, you will be aware of the most commonly used terms, and have an idea how to select the right one for any given shipping scenario.
What are Incoterms Exactly?
The best place to start an incoterms guide for new shippers is with an explanation of what incoterms are. As mysterious as the label itself might sound, it is just a short way of saying international commercial terms.
While you might initially be confused about their application, the universally recognized incoterms rules exist to aid communication and reduce confusion for buyers and sellers engaged in commercial transactions.
Published by the International Chamber of Commerce (ICC) and revised on a ten-yearly basis, incoterms define the transactional obligations and responsibilities of a buyer and seller.
Any incoterm can (and should) be applied as a standard, clarifying who will bear the costs of transportation and the risk of loss during the carriage and transfer of goods. By condensing these obligations into a short-form classifier like free on board (FOB), incoterms reduce reliance on an understanding of legal and commercial jargon—making them relatively straightforward for anyone in business to understand.
Key Things to Learn About Incoterms
The challenge, for a newcomer to international trade, is not so much around understanding each incoterm, but more about selecting which to apply to a particular sales and carriage contract. However, you may only ever use one or two of the terms regularly as an international trader, and with ICC revisions just once a decade, you should have little trouble keeping up to date with changes.
The key responsibilities defined by an incoterm are as follows:
- The place of destination for the shipment (the point where the goods are considered officially delivered from the seller to the purchaser);
- The cost of transportation (who pays for each stage of domestic and international transport);
- Insurance costs (defines whether the purchaser or seller is responsible for insuring the shipment's contents);
- The formalities of importation and exportation (determines who has responsibility for export and import customs declarations).
It’s also worth noting that there is some interplay between the ICC’s incoterms and the broader international trade laws imposed under the UN’s Convention on Contracts for the International Sale of Goods (CISG). While it is a complex topic to understand, you might wish to research the relationships between the CISG and the incoterms, but this need not be an early priority if you are a new shipper.
Current Incoterms for International Trade
The last revision of incoterms was in 2010, completed under the ten-yearly convention of review and in recognition of changing trends in global shipping and the need to improve cargo security. Another revision is due in 2020, but until then, the 11 current incoterms are as follows:
EXW Ex Works: Under the Ex Works incoterm, the buyer takes possession of the goods at the seller’s factory, warehouse, or store, and hence assumes responsibility for all transportation costs, and the risks of getting the products to their final destination.
FCA Free Carrier: FCA means that the seller of the goods is responsible for export documentation and customs formalities, transportation-cost, and risk up until the shipment is handed over to the first carrier. If the first carrier is a freight forwarder in the seller's country, and the handover takes place at the forwarder's warehouse, the buyer will own the risk—and costs—from the forwarder's warehouse through to the goods' ultimate destination.
FAS Free Alongside Ship: Free Alongside Ship means the seller will bear all costs and risks in the export country, apart from loading the cargo onto the exporting vessel. The seller is also responsible for export formalities. The buyer takes possession of the shipment when it is on the dockside and ready to be loaded onboard the vessel.
FOB Free On Board: FOB terms require the seller to carry all costs and risk up to and including the loading of the cargo onto the ship that was nominated by the buyer. In this scenario, the buyer takes no responsibility for any shipment stages in the exporting country.
CPT Carriage Paid To: This term creates quite a broad division between ownership of costs and assumption of risk. The seller may be responsible for all carriage costs involved in shipment to the buyer’s destination terminal. However, the buyer assumes risk after the shipment’s arrival at the seller’s departure terminal.
CIP Carriage And Insurance Paid To: CIP is the same as CPT, except for the responsibility to insure, which for the international leg of carriage by ocean or air, lies with the seller. However, the risk liability transfers to the purchaser when the cargo is in the hands of the first carrier.
CFR Cost And Freight: The CFR incoterm places the onus on the seller to pay the cost of carriage to the destination-port in the country of import, but the purchaser assumes liability when the cargo is aboard the exporting vessel.
CIF Cost, Insurance, And Freight: Under the incoterm CIF, the seller pays all carriage costs to the purchaser’s destination port, and must also arrange and pay for the insurance.
DAT Delivered At Terminal: When shipping under the DAT incoterm, it is the seller's responsibility to cover all export and international transportation costs and insure against risk, until the point of unloading at the import terminal in the buyer's country. The importer assumes all responsibilities once unloading is complete.
DAP Delivered At Place: DAP terms stipulate that the selling party is responsible for everything except the import customs declaration and clearance, and that the responsibilities transfer only when the shipment arrives at the purchaser's final destination.
DDP Delivered Duty Paid: This term places all shipping responsibilities and liabilities, door-to-door, in the hands of the seller. The buyer is required only to unload the consignment at its ultimate destination.
Most Commonly Used Incoterms
As mentioned earlier, it is unlikely that your business will need to use many of the 11 incoterms described above. Indeed, most enterprises use only one or two, with Ex Works and FOB being among the most popular:
Ex Works: This incoterm is popular with purchasers who don’t feel comfortable about sellers’ pricing of local services, and with vendors who don’t want to get involved in managing outbound logistics.
FOB: Enterprises that frequently import products from overseas tend to like the FOB arrangement because they don’t need to negotiate rates with local carriers and service providers in the exporter’s country.
However, FOB is also one of the most misunderstood of these shipping trade terms, and many transactors overlook the fact that it is only intended for non-containerized freight traveling via ocean or inbound waterway routes.
How to Choose the Right Incoterm
Of course, it’s one thing to know the meaning of all the freight incoterms you could use, but another to know which one is right for a given sale or purchase. While freight forwarders can always advise you about which incoterm might be appropriate, the decision will ultimately be in the hands of your business.
Therefore, it will pay to understand how each term affects an international sales agreement, especially when dealing with import and export finance instruments like letters of credit. Banks and financial institutions need assurances that the parties involved in international contracts of sale are aware of their obligations and liabilities.
Considerations for Exporters and Importers
The factors driving your choice of incoterm will depend upon whether your enterprise is the buying or selling party. For example, if you are the exporter, does your business have the capacity to pay the costs and bear the risks of transportation to the point of delivery, or would it be better to limit those obligations to within the borders of your country, where you have more control over logistics?
On the other hand, perhaps your company imports regularly, and as a purchaser, has developed strong relationships with carriers and forwarders in the export country as well as at home. In this scenario, you might wish to have control of insurance and transportation arrangements, because you can maintain transparency and perhaps benefit by consolidating shipments in the exporting country. It’s also vital to realize that some incoterms might not be compatible with your chosen mode of transportation, and that the restrictions may not immediately be evident to the uninitiated.
As mentioned earlier in this article, for example, you should use FOB only for sea freight. FAS, CFR, and CIF terms too are exclusively for surface transportation. You can narrow the choice even further with the knowledge that some incoterms are not suitable for containerized freight.
Incoterm Decisions are a Two-Way Street
As a final word of advice, remember that when negotiating an international contract of sale, there are two parties involved. The best choice of incoterm will be the one that benefits the vendor and the customer in equal measure.
In other words, be sure to discuss incoterms with your trading partner. It is also acceptable to insert contractual clauses that change some elements of the chosen incoterm, enabling a shipping arrangement that suits everybody.
Before finalizing any contract of sale as a buyer, it’s a good idea to ask your supplier for quotes based on the incoterms you believe you will use. Then ask your freight forwarder to provide quotes that you can compare against those of the supplier. The result might help you base your final decision on what proves the most economical path to receiving your shipment.
If you don’t have a regular freight-forwarding partner, you can always talk to the team here at Shipa Freight. Our network covers more than 100 countries, and we ship by air or ocean, door-to-door at very competitive rates. We can also help you select the right incoterms for your shipments. To find out more, contact us online today, and we’ll be pleased to answer your questions.
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