Knowing what Incoterms are and why they are so important is to going to be the foundation of learning how to export. Think of Incoterms as code words that are used within international trade that make it 100% clear where everybody’s responsibility lies as far as the place of delivery, the division of cost and where the risk passes to the buyer.
Incoterms: A Definition
Incoterms are a pre-defined set of three letter codes created by the International Chamber of Commerce (ICC) which were established so there would be clear international commercial terms, as far as where costs and risks lie within each party (the buyer or the seller) when making an agreement in moving goods from the source to the destination, hopefully reducing issues within a supply chain.
Incoterms were very first created in 1923 but over the years they’re updated and amended. So far, they’ve been updated 8 times since 1923 and we’re now using Incoterms 2010. There’s due to be an update in 2020 in which case Incoterms 2020 will become the current standard.
Incoterms is an acronym:
- IN stands for International
- CO stands for Commercial
- TERMS are obviously terms
- 2010 denotes the year of latest revision
Why Do We Need Incoterms?
When we buy something from eBay, we expect the seller to receive our money and send us the product that we’ve paid for to our named destination (usually our home address). If we don’t receive this product, we can contact the seller and address the problem or should that fail, contact either our credit card company and/or eBay and they will act on our behalf and settle the dispute.
Obviously in buying something on eBay the process is pretty simple but the seller may say once they put the product in the post and have the proof of postage, it’s no longer their problem.
If the package is lost in between, it could be the fault of the post office or maybe it was delivered to a neighbor. There are variables that come into play and if something goes wrong, the responsibility of the buyer and seller is not so clear. However, on this small scale it’s usually reasonably easy to resolve.
Incoterms, or these “code words” were developed to clear up any issues on exactly who is responsible for what and make sure that there cannot be any misunderstandings. The prime purpose in developing Incoterms is to identify where the buyers and where the sellers responsibilities lie under three main areas:
- The place of delivery from the seller to the buyer.
- The transfer of risk from the seller to the buyer.
- The division of costs between the seller and buyer.
Essentially it stops any confusion for what the buyer and seller pays for.
How Many Incoterms Are There?
There are 11 main Incoterms that are divided into 4 categories. There are new Incoterms due to be developed for 2020 so this may increase but these are the 11 current Incoterms in use on the international logistics stage today.
The following apply to any mode of transport:
- EXW Ex Works
- FCA Free Carrier
- CPT Carriage Paid To
- CIP Carriage and Insurance Paid To
- DAT Delivery at terminal
- DAP Delivery at place
- DDP Delivered Duty Paid
For sea and inland waterway transport:
- FAS Free Alongside Shipping
- FOB Free on Board
- CFR Cost and Freight
- CIF Cost, Insurance and Freight
Before we dive too far into Incoterms, review our infographic below which illustrates where the obligation and risk passes from the seller to the buyer.
To embed this Incoterms infographic, copy and paste the code below:
Which Incoterm Should I Use?
It’s beyond the scope of this blog to go into detail on each Incoterm as it would take quite some time but as you’ve probably guessed, which Incoterm(s) you should be using depends on various circumstances. Not least, your customer may ask you to deliver under a preferred set of Incoterms, so it’s wise to be well informed on what all 11 Incoterms mean and how to use them.
In my experience, the majority of companies that I deal with, tell me that they try to trade under EXW as its ‘Easy” and requires the minimum involvement in the logistics of delivering to their overseas customer.
Two Very Different Incoterm Examples
Using the following two examples, you can see there are two very different ways to achieve the same thing, namely getting a delivery of your goods to your customer.
Scenario One Using EXW
Here’s an example of what’s needed if you as a seller were to export under the Incoterm EXW (Ex Warehouse):
- Place of Delivery: The sellers warehouse door
- Risk Passes: At the sellers warehouse door
- Cost: Cost of production plus profit (or the price on the invoice)
- Export packing (if required)
As you can see, by using EXW, you have very little work to do other than preparing the goods, boxing them up and have the shipment waiting at the named place (usually your warehouse door) ready for collection.
Delivery Ex Works is great if you can agree on that with your customer but what if they request any terms of delivery? This is where you’ll need to know and understand Incoterms rules.
Scenario Two Using CFR
Now let’s say that you’ve negotiated and landed a large order, that’s a profitable deal with a new customer and they’re potentially going to make many more orders in the future.
They don’t want to organise the logistics of collecting their order from your warehouse but instead want you to organise the delivery to them. They ask you to complete the order under the Incoterm CFR and expect in this case, the you as the seller delivers. This very much changes the work involved from the sellers point standpoint:
- Place of Delivery: On board the vessel at named port (or inland waterway transport vessel)
- Transfer of Risk: When goods are placed on board the vessel
- Division of cost: Cost of production plus profit (or the price on the invoice)
- Export packing if required
- Export Entry Declared to HMRC
- Weight Certificate
- Transport to dock of Export
- Terminal Handling Charges
- Security check if required
Contrary to EXW, by trading under CFR there is much more work to do in preparing the order for export and transferring the shipment to the dock in order to be transported, not to mention you as the seller are extending your risk because you’re not “off the hook” until the goods are on the vessel.
There may also be a cost implication as you’ll have to cover transportation from your warehouse to the dock and the various documentation as listed above.
As a seller, EXW is preferable of course but there will be times where a buyer asks you for something different, so be prepared. In this case you would need to know that trading under CFR will require the following:
- You as the seller must have a basic knowledge of the export procedure
- Obtain Export Licence IF required
- Arrange transport to port of loading
- Make an export entry to HMRC
- Register for EORI status
- Obtain freight quotation from Freight Forwarder or direct from shipping line
- Issue Bills of Lading Instructions
- Arrange for Bills of Lading to be forwarded to the seller according to the method payment involved in the contract between seller and buyer
There’s much to understand in exporting your orders around the world and if you really want to grow to a global scale, you must have an excellent grasp of export procedure.
Contract of Carriage and Insurance
Incoterms also address such matters as:
- Contract of carriage and insurance
- Licences, authorisations, security clearance and other formalities
- Checking of packaging and markings
- Delivery document
Depending on the Incoterm used, it’s either the seller or buyers’ responsibility to undertake the contract of carriage and insurance. This is also very important.
By quoting a particular Incoterm the responsibility for delivery of the freight and its insurance, falls either upon the seller or the buyer, which is why it’s so extremely important to understand the Incoterm you’re trading under. If you misunderstand this, you may have to pay for these costs when you’re not expecting to.
For example, under “EXW subject to Incoterms 2010” it is the responsibility of the buyer to arrange carriage and Insurance (should they want insurance).
However, under “CIF subject to Incoterms 2010” it flips to the sellers’ responsibility to arrange freight delivery and insurance.
Three letters can have a massive impact on a deal, costs and profit margins and must be understood.
Marine insurance, as like any other insurance, is important. If your good are damaged or destroyed during shipment, you’ll need to make a claim.
Under the Incoterms CIF and CIP, the seller is responsible to insure the cargo.
The seller must therefore obtain, at their expense, cargo insurance complying at least with the minimum cover provided by clause C of the Institute Cargo Clauses. Cover for Clause A or B may be obtained by the seller at the buyers request.
Both parties must fully understand their separate obligations when using Incoterms 2010 in the sales contract and in the above case, fully understand the insurance cover offered by clause A, B and C.
Generally, clause A insurance covers all risks with certain exclusions, clause B and C offers limited risks with certain exclusions.
It’s up to the buyer to make it clear to the seller which insurance cover they require for their cargo when they request a quotation, however the seller is obliged only to obtain minimum cover as per Incoterms 2010.
As a general rule the type of insurance most suitable for any particular shipment can be determined by considering the following:
- The nature of the cargo (fragile or robust)
- Method of shipment
- LCL (less than a container load) or FCL (full container Load)
- Direct service, port to port or trans shipped
- Port conditions at port of loading and port of discharge (including trans shipment ports)
- How is the cargo packaged? (i.e. Wooden crates, tri-wall carton)
This information is available from your Freight forwarder.
As a word of advice, there are many ports worldwide known for their lack of security, inefficient labour force and mechanically unsound cranes, so be aware of varying levels of service.
- Nature of Cargo
- Direct flight or trans shipped
- Airport conditions at airport of dispatch and arrival
Again, as with sea ports, many airports worldwide can lack quality security, offer insufficient warehousing (for example, cargo exposed to the elements) and rough handling of cargo.
Remember, as a tip, Clause A,B,C does entertain a claim due to loss, damage or expense caused by insufficient or unsuitable packaging (4.3 under exclusions).
Packaging and Markings
Under all Incoterms 2010 the seller is responsible for packing and related costs.
Incoterms 2010 states, “The seller may package the goods in the manner appropriate for their transport, unless the buyer has notified the seller of specific packaging requirements before the contract of sale is concluded”.
As an example, an order is received by the buyer which states EX WORKS (EXW) and the buyer does not indicate how they require the order to be boxed.
The seller is not given any information about the method of shipment by the buyer either. How does the seller pack the goods as all they know is the buyers’ truck will collect the consignment the warehouse?
The seller knows that his buyer is in West Africa so it’s a reasonable assumption that the cargo will either be delivered by air or sea.
What can the seller do regarding packing requirements?
They could take the attitude:
- As I was not given any particular packing instructions, I’ll pack the way we normally do.
- I’ll contact the buyers freight forwarder and enquire about the intended method of shipment.
- Prior to accepting the order, I’ll ask the buyer if they have any specific packing instructions, pointing out to the buyer that if they are insuring the cargo themselves they should keep in mind clause 4.3 under
Obviously, it would be great if the second or third option were happen but many times, it’s the first and this can lead to further problems and stress.
Licences, Authorisations, Security clearance and other formalities
Under the following Incoterms and where applicable, the seller must obtain, at their own risk and expense, any export licence or other official authorisations, complete all customs formalities necessary for the export of the goods and under DAP, DAT, for their transport through any country prior to delivery:
Where applicable the seller must obtain, at its own risk and expense any export and import licences or other official authorisation and carry out all customs formalities necessary for the export of the goods, for their transport through any country and for their import.
Costs and Responsibility
The seller must take into account any costs and time associated in obtaining:
- Export/import licences as per Incoterms 2010 used in the contract
- Export entry costs as per Incoterm 2010 used in the contract
- Import customs duty as per the Incoterm 2010 used in the contract
Provision of Information and Related Costs
Under the following Incoterms, the seller must, where applicable and in a timely manner, provide or render assistance in obtaining at the buyers request, risk and expense, any document and information, including security related information that the buyer needs for the import of the goods and/or for their transport to the final destination.
The seller must reimburse the buyer for all costs and charges in obtaining documents and information:
IMPORTANT: The seller is entitled to charge the buyer for such documents as a certificate of origin, movement certificates etc.
Many buyers think that they cannot be charged for such a service and if you’re working on tight margins, every penny counts.
Another area to understand are the documentary requirements, which covers:
- Certificates of Origin
- Movement Certificates
- Bills of Lading
- Master and House Air Waybills
EXW The seller has no obligation to the buyer.
FCA The seller must provide at the sellers expense, proof that the goods have been delivered in accordance with delivery instructions. The seller must provide assistance to the buyer at the buyers expense, risk and cost in obtaining a transport document
CPT and CIP
If customary or at the buyers request, the seller must provide the buyer, at the sellers expense, usual transport document(s) for the contracted transport method.
The transport document must cover the contract goods and be dated within the period agreed for shipment . The documents must also enable the buyer to claim the goods from the carrier at the named place of destination and enable the buyer to sell the goods in transit by the transfer of the document to a subsequent buyer or by notification to the carrier.
When such a transport document is issued in negotiable form and in several originals, a full set or originals must be presented to the buyer.
CFR and CIF
The seller must provide at it their own expense to the buyer without delay, the usual documents for the agreed port of destination
The transport document must cover the contract goods be dated within the period agreed for shipment, enable the buyer to claim the goods from the carrier at the port of destination and unless otherwise agreed, enable the buyer to sell the goods in transit by the transfer of the document to a subsequent buyer or by notification to the carrier
When such a document is issued in negotiable form and in several originals, a full set of originals must be presented to the buyer
DAT, DAP and DDP
The seller must provide at their expense, a document enabling the buyer to take delivery of the goods at the named place.
FAS and FOB
The seller must provide the buyer, at the sellers expense with the usual proof that the goods have been delivered at the named place, unless such proof is a transport document, the seller must provide assistance to the buyer at the buyers request ,risk and expense in obtaining a transport document.
2020 Will See Radical Changes to Incoterms
International Chamber of Commerce
Since the first edition in 1936, The International Chamber of Commerce( ICC )has always reacted to changes in international trade and reflected this in their Incoterm revisions.
It looks like our old friend and much loved EXW is on the way out, which will make it a harder for the passive exporter who relied on EXW to free themselves from the logistics and paperwork involved in International trade. If you’re one of these guys, you will need to get to grips with the required documentation.
FCA looks as if its going to be split out as FCA land and FCA marine.
DDP is looking like it may also be on its way out to be may be replaced by two new terms, of which we don’t know yet but we will keep watching.
Lastly, just as we thought it wouldn’t get anymore complicated, the ICC may introduce three new terms:
DTP delivered paid to terminal
DPP delivered paid to place
CNI is just a proposed term that would fill the long overdue gap between FCA, CFR, CIF
It’s rumored that Incoterms 2020 will also address transport security and the relationship between Incoterms 2020 and the international sales contract as well as the regulations on transport insurance.
So there’s a lot in the working at the moment and seems like the new Incoterms 2020 could be quite a change and a step up. As soon as the ICC confirm the new terms, which they we expect to be around September 2019, we will be updating you with exact information and how it will effect you.
5 Benefits For Using Incoterms
Overall, the use of Incoterms is important and avoids many “would-be” conflicts.
- It eliminates any misunderstanding between the buyer and seller regarding:
- The place of delivery
- The division of cost
- Where the risk passes from seller to buyer
- Allows the buyer and seller to choose how involved they wish to be in moving goods through the supply chain.
- It gives control regarding the level of insurance required and identifies which party is responsible for insuring the cargo.
- It defines who is responsible for export packing requirements and the correct packing.
- Lastly, it identifies which party is responsible for producing export documentation, shipping documents, import and export licences.
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