What are Incoterms and How Are They Used

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 2010 A Definition

Briefly, as this can be a little dull, 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.

They 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.

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:

  1. The place of delivery from the seller to the buyer.
  2. The transfer of risk from the seller to the buyer.
  3. 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:

  1. EXW Ex Works
  2. FCA Free Carrier
  3. FAS Free Alongside Shipping
  4. FOB Free on Board
  5. CPT Carriage Paid To
  6. CIP Carriage and Insurance Paid To
  7. CFR Cost and Freight
  8. CIF Cost, Insurance and Freight
  9. DAT Delivery at terminal
  10. DAP Delivery at place
  11. DDP Delivered Duty Paid

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):

  1. Place of Delivery: The sellers warehouse door
  2. Risk Passes: At the sellers warehouse door
  3. 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:

  1. Place of Delivery:  On board the vessel at named port (or inland waterway transport vessel)
  2. Transfer of Risk:  When goods are placed on board the vessel
  3. 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.

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.

What’s Changing?

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.

Import Export Training Course Online

We’re currently offering our online import export training course for just £199 so now’s a good time to get stuck in and get to grips not just with Incoterms but all aspects that you need in order to streamline your import export process and keep your profitability as strong as possible.

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