Incoterms, more complicated than just FOB or EXW

Incoterms, why should you care?

I've been surprised several times by how little companies either care or understand the use of Incoterms. For example, I once had a vendor thoroughly upset that my company had refused payment of a vendor invoice for an order that was shipped DAP but never received at port of destination. The carrier deemed it lost in transit but the vendor was threatening to send the collectors after my company. In another case a company had a policy for DAP terms but didn't hold the sourcing group accountable so they were constantly allowing the vendors to ship with EXW, the ballooning freight spend was later flagged by the accountants.

In my experience there has been a lack of training/ownership for either the sales or purchasing group on Incoterm basics and obviously a lack of company wide strategy. Mistakes like these can end up being very costly. This article looks into a few more common terms and gives you, the reader, some ideas on what you should be using in your business.

What are Incoterms?

The International Chamber of Commerce publishes periodically internationally accepted trade term definitions that are then used worldwide in global and domestic sales contracts. Its a commonly agreed language that defines risk, carriage and cost. Incoterms don't specify where ownership or title transfer, that is between the buyer and seller to separately specify. There are currently 11 rules in the 2010 version, divided into four groups: C, D, E and F, with each three letter rule starting with one of the four group letters.

EXW - Ex Works

This is the simplest of the Incoterms, it requires for the buyer to load the vehicle at the location where the seller has made them available. If you are buying from overseas, make sure you make arrangements for the loading and pickup of your items! The risk in transportation, export and import clearance and the cost for both is the buyers responsibility.

CIF - Cost, Insurance and Freight (Sea and Inland waterway Transport)

The seller delivers the goods, cleared for export, on board the vessel. The seller pays the costs and freight to the named port of destination and the seller contracts insurance to cover for risk or damage during transit. However, the  risk for loss or damage is transferred once on-board the vessel and the seller is only required to obtain insurance for the minimum cover. Once at the port of destination, the buyer needs to pay any offloading chargers, import duties, and transport to the final destination.

FOB - Free On Board (Sea and Inland waterway Transport)

This is my absolute #1 favorite misunderstood and abused Incoterm. First, it is only for use for waterway transport, not ground freight. Second, it should only be used for bulk or non-containerized goods. The seller pays for the delivery of the goods on-board the vessel, this includes any Terminal Handling Charges, and at which point the risk for transport or loss and any further costs are the buyers responsibility. If you therefore lose a shipment, check where the loss occurred, it may end up being the sellers responsibility! For containerized goods, use FCA instead!

FCA - Free Carrier (Any transport method)

This is a basic rule for situations where the buyer arranges the main carriage. The seller delivers the goods to the named place of delivery, where the risk and costs transfer to the buyer. This could be a forwarder's warehouse, terminal or hub. If the named place is the sellers location, then the seller is responsible for loading the goods on the vehicle at which point the risk and responsibility for costs transfers. A buyer therefore should never use EXW for non-bulk goods due to this notable difference. Lastly, the seller is responsible for export clearance but not for insuring the goods for pre-carriage damage.

DAP - Delivered at Place (Any transport method)

This rule replaced the old DDU (Delivered Duty Unpaid) but shares many of the same responsibilities. The seller arranges and pays for delivery to named place but not the unloading from the vehicle. The buyer is responsible for import clearance and costs, including any terminal charges at the named place. The risk also transfers at the named place, damage incurred during unloading is therefore the buyers responsibility. Lastly, the seller is not obligated to insure the goods in transit.

DDP - Delivered Duty Paid (Any transport method)

The only rule that defines that the seller is responsible for the, carriage to, import clearance, import/export duties and other costs. For a buyer, it is the least bureaucratic but also allows for the seller to upcharge for the extra service. In some countries, this can also be extremely difficult for the seller since they may not have a presence in the country causing additional headache in the import clearance procedure.

There's several other Incoterms that may be more applicable to your business needs. The above six covers most bases and a solid understanding will offer you the most amount of control and liability that you are willing to bear. I highly recommend you incorporate Incoterms into a recurring training course for your sales, purchasing and accounting staff. After all, an accountant should not pay an invoice for something that your company may not be liable for!


References: 
KoganPage, Master the 11 Incoterms Rules, Gwynne Richards, 13-Jul-2016
inbound logistics, Using Incoterms to Simplify Global Sourcing, Simon Kaye, 31-Jan-2012
International Chamber of Commerce, Incoterms rules 2010