What, exactly are Incoterms? More importantly, how do they impact your bottom line?
As a buyer, your job is to source materials that fit into your budget, arrive on time, and are in line with your quality standards.
Part of a successful procurement strategy is making sure that you and your suppliers are on the same page. You will need to know who is responsible for shipping costs, insurance, and risks associated with a sales contract.
Which, let’s admit—gets a bit challenging when you’re evaluating international contracts.
That’s where Incoterms or International Commercial Terms come into play.
Let’s take a look:
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What are Incoterms?
Incoterms were first introduced in 1936 by the International Chamber of Commerce (ICC). Since then, the ICC has updated the rules every 10 years to stay current with the latest developments. We’re currently using Incoterms 2010, though next year, things may change.
As it stands, there are 11 Incoterms in use—which cover a range of responsibilities and obligations for buyers and sellers.
For buyers, some Incoterms offer more control over shipping costs—and stand to save you some serious cash down the line. While others provide benefits in the form of convenience, where sellers handle the entire shipping process.
It may be helpful to think of them as a spectrum representing liability in terms of costs and risks:
Buyers must consider Incoterms before they sign a contract, or else they might find themselves dealing with unnecessary complications. Factors such as insurance, documentation, and coordinating with local freight companies can impact profitability just as much as the products themselves.
With that in mind, here is a quick rundown of the 11 Incoterms that buyers should know.
1. EXW: Ex Works
Under EXW, the seller makes the goods available to the buyer at the named place of delivery. Typically, this is a factory or warehouse where the buyer arranges for pickup and is responsible for the rest of the shipping journey.
It means the buyer is responsible for getting the product out of the seller’s warehouse, onto the mode of transportation, through customs, and to their warehouse.
EXW terms pass the bulk of the responsibility onto the buyer. The only thing the shipper needs to do is make sure the goods make it to that initial pickup point.
While that might sound like the buyer gets the short end of the stick, EXW does have some distinct benefits.
The main benefit is that EXW terms come with few surprises. The buyer has full control over the shipment, so they’ll get a clear picture of upfront costs—and can make sure that the shipper isn’t padding margins or inflating delivery costs.
Still, EXW does have a downside. Customs clearance can be a challenge. For example, if any information is entered incorrectly, the buyer may be liable to pay for any costs associated with a customs inspection.
Another potential roadblock is export licenses. Often, suppliers who don’t have an export license prefer to use EXW so that they can pass the costs along to the buyer.
Be sure to ask about the export license during the negotiation phase, as they can get quite expensive.
That said, EXW offers more pros than cons—all costs are presented up front, and it’s relatively rare to incur any additional charges.
2. FCA (Free Carrier)
FCA, or free carrier terms mean that a seller delivers the shipment to a third-party freight forwarder as specified by the buyer. Once the shipment arrives at the delivery point, the buyer assumes all risk. So, this might mean that the seller has a truck drive the shipment to a second location and the hand-off happens when the buyer-arranged truck comes to pick it up. In this case, the buyer might pay a small fee for the initial drop off, but the rest of the responsibility falls on the shoulders of the buyer—much like EXW terms.
3. FAS (Free Alongside Ship)
FAS terms state that the exporter is responsible for ensuring the goods clear customs and delivering shipments to the point of origin. FAS applies only to sea or inland waterway ports, and like EXW, the shipper is solely responsible for the goods until they arrive at the port.
Seller drops it off but doesn’t take care of loading. It’s your responsibility to get it over the rail, on the boat or mode of transport.
It’s important to note that while the seller is responsible for delivering the buyer’s goods and preparing customs documentation, the buyer is responsible for loading the items onto the vessel and everything that happens after that point.
The shipper is not responsible for transport, insurance, or delivery. While there is no apparent benefit for buyers to take on the task of loading the ship, it might be a good option for buyers who wish to have more control over the costs and responsibilities associated with the shipment.
4. FOB: Free on Board
FOB is a term that lays out the price of goods, including freight, at the seller’s expense. The location of delivery is where responsibility transfers from seller to buyer. The buyer is responsible for assuming any additional shipping costs—for example, if the freight needs to be shipped to another location like a warehouse or retail store.
Buyers benefit from using FOB, as the seller is liable for any damage that happens during transit, as well as coordinating things like customs documents.
The downside for buyers is considering shipping terms along with their inventory costs. Buyers using FOB terms need to be strategic about placing an order—the more shipments procurement brings in, the more they’ll spend on insurance and shipping. As such, it’s best to use FOB if you’re able to consolidate shipments.
5. CPT – Carriage Paid To
The seller delivers the goods to a carrier at an agreed-upon location. They assume the responsibility until the delivery is picked up by a freight forwarder—at which point, the risk transfers to the buyer.
6. CFR – Cost and Freight
The seller is responsible for covering all freight and costs until goods arrive at the port of destination. From the buyer’s perspective, the main benefit of CFR is that the seller deals with the contracting process and arranges the shipping logistics.
The buyer assumes the risk when the shipment is loaded on the ship. So, they’ll be on the hook for securing insurance and import documentation.
7. CIF: Cost, Insurance, Freight
Cost, insurance, and freight terms are a lot like CFR, but now the seller is also responsible for insurance, too. Again, the risk of loss or damage is then passed to the buyer once those goods are on board.
We should note, though, CIF terms only require the seller to obtain the minimum coverage.
According to the ICC, CIF is best for non-containerized shipments or bulk cargo. This rule applies only to shipments transported by water—and usually is reserved for situations where a seller has direct access to the vessel.
In this case, it’s the seller’s job to arrange for shipment, pay for insurance, deal with export forms, and pay for loading and unloading costs. The risk passes from seller to buyer once the items are on the ship—however, the seller does pay for shipping.
The seller will get your goods across the ocean. It’ll arrive at your home port. They’ll take responsibility for the products up until the point they enter your country.
On your end, you’ll still need to arrange for transport to the final destination.
8. CIP – Carriage and Insurance Paid
Here, the seller delivers the shipment to the carrier, much like CPT. However, in this case, the seller pays for freight and insurance until the shipment reaches its final destination. The risk is transferred to the buyer when the shipment is picked up from the seller.
9. DAT – Delivered at Terminal
Delivered at Terminal (DAT) means that the seller is responsible for getting the goods to the buyer’s home terminal. This might be an airport or a seaport, or other point of entry. With DAT, sellers take on the risk, responsibility, and costs associated with the shipment.
When goods arrive at the terminal, the buyer assumes responsibility. The buyer will need to arrange for import clearance, unloading supplies, and arranging for transport back to the final destination.
10. DAP – Delivered at Place
DAP, or delivered at place, means the seller is responsible for almost the full process. This incoterm takes it one step further than DAT. Sellers coordinate the pickup, prepare export documentation, insurance, and pay for freight from point of origination to an agreed-upon location. Sellers also bear the risk up until that point, when the buyer takes over and handles import clearance and the transport to the final destination.
11. DDP: Delivery Duty Paid
DDP means that the seller assumes all of the risk and responsibility associated with the shipment, including import clearance and payment. DDP can be used with any mode of transport, be it air, truck, ship, or courier—or some combination of those methods.
Sellers might not be so keen on DDP terms, as they’re responsible for all customs and clearance paperwork—and any mistakes or miscalculations could come back to bite them.
From the buyer’s perspective, the most obvious benefit is the convenience of having the seller take care of everything from customs to insurance to freight.
In some cases, buyers may be able to take advantage of a seller’s premium rates, though in others, there’s little room for negotiation—and high shipping costs can eat into your bottom line.
Buyers should understand Incoterms, with an awareness that these rules don’t cover the full scope of international procurement. Incoterms set the standards, but they don’t set the rules for title transfer, quality control, or other important factors.
Here’s a nice visualization of who handles what, broken down by Incoterm.
Weigh options carefully when setting up the contract. Deferring ownership as long as possible might sound appealing—it’s certainly more convenient—but it can delay the accounting process.
For example, teams may be waiting for an invoice for shipping and insurance based on DDP terms. That impacts the ability to accurately forecast profits and reconcile the books.
Alternatively, paying shipping costs upfront, a la EXW terms, can feel more expensive. However, this Incoterm gives buyers full control over shipping—they can negotiate with freight forwarders and track shipments online.
Of course, Incoterms are one piece of the procurement puzzle, along with budgeting, ordering, and implementing approval flows.
Contact ProcurementExpress.com to learn how to bring more visibility into the buying process.
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