If I mention Incoterms® to you, is it all Double Dutch? Or do you have a vague recollection of learning about them sometime but it all being too complicated to really follow or use in a practical way? If that sounds like you, then this is a post specially for you, and by the end of it you should know your Incoterms®.
What are Incoterms® anyway? 🤷🏻♀️
The Incoterms® are a set of rules published by the International Chamber of Commerce (ICC), regulating the transfer of ownership and risk in international trade. These standards are used worldwide so that traders understand who is responsible for paying for which parts of a transaction and to regulate any legal disputes which may arise.
The Incoterms® are the only universally accepted set of rules governing the sales of goods, meaning that if you want to do international business it’s essential to at least have a basic working knowledge of how they function. If you don’t know your Incoterms® off by heart, you can always check the details, but you need to know which points you need to be careful about. Using the right Incoterm® will help avoid confusion between you and your business partners.
The ICC first published their Incoterms® in 1936, & has maintained them ever since. Usually they are revised every 10 years to take account of developments in international trade, so even if you’ve worked with Incoterms® in the past, you should always check to see what has changed. The latest edition Incoterms® 2020 is available in 29 languages according to the website of the ICC.
Where does the name Incoterms® come from?
Incoterms® is an abbreviation standing for “International Commercial Terms” and is trademark protected by the ICC. It consists of a set of 11 rules governing international trade.
What is regulated within the Incoterms® 2020?
The Incoterms® govern 3 main questions around the responsibilities of buyers and sellers in export transactions:
- Who will pay for which costs in the logistics chain?
- Where does the transfer of risk take place in this process (at which point are the goods considered to be “delivered”)?
- who has which obligations in terms of documentation and export formalities?
Consequently, if you’re working internationally, either buying or selling you need to understand what each Incoterm® means for your business in terms of cost, risk and responsibility. Choosing the wrong terms of trading can easily lead to additional costs which you didn’t budget for, which is why I decided to prepare this post about knowing your Incoterms®.
An Overview of Incoterms® 2020
The Incoterms® 2020 are divided into two main groups. There are 7 that can be used for any mode of transport (or multimodal transport), and 4 others which can be used for sea or transport by inland waterways. It’s important to remember that whilst I’m talking here about individual terms very generally such as EXW, in actual fact, to have the correct legal protection, you ALWAYS need to include a place or destination (depending on what is relevant). The more precisely you can define those named places, the less room for misunderstanding between seller and buyer.
Overviews of the Incoterms® usually list them by increasing responsibility for the seller (so from least to highest) as in the list below. The names of the individual clauses come from the part which the seller plays in the execution of that clause.
The 7 Incoterms® 2020 clauses that can be used for any mode(s) of transport are:
EXW – Ex Works (insert place of delivery)
FCA – Free Carrier (Insert named place of delivery)
CPT – Carriage Paid to (insert place of destination)
CIP – Carriage and Insurance Paid To (insert place of destination)
DAP – Delivered at Place (insert named place of destination)
DPU – Delivered at Place Unloaded (insert of place of destination)
DDP – Delivered Duty Paid (Insert place of destination).
Note: the DPU term replaces the old DAT (delivered at terminal), with the additional requirement for the seller to unload the goods from the arriving means of transport.
The four Incoterms® 2020 clauses for Sea and Inland Waterway Transport are:
FAS – Free Alongside Ship (insert name of port of loading)
FOB – Free on Board (insert named port of loading)
CFR – Cost and Freight (insert named port of destination)
CIF – Cost Insurance and Freight (insert named port of destination)
So let’s dig into all of those in a bit more detail, so that at the end you can really say that you know your incoterms. For those of you working in detail in international trade, I’d recommend that you buy an up to date copy of Incoterms® 2020 on the ICC website. That is something that you should have at hand as a work of reference.
Multimodal Terms in More Detail
EXW Ex Works
This is the absolute minimum level of responsibility on the side of the seller, as he just has to make the goods available at whichever place is named in the contract. So that could be “at ramp” in his warehouse, at the factory door etc. The seller has all the costs and risks of getting the goods to that named point and after that has no more responsibility.
In concrete terms that means the seller doesn’t have to load the goods onto a vehicle, nor does he have to make any export clearance. (He just has to provide enough information that the buyer can make any clearance that is necessary.)
Personally, I don’t like to use this, as a lack of understanding about the precise responsibilities can come back & bite you – do you as a buyer really want the seller to load your truck or container at your liability and cost? And seller, do you really not want to have more information where your goods are going to end up? (This can be a tax issue remember & impact your reporting). If several possible points of delivery are specified, the seller can choose which one to use and the buyer is obliged to collect. The transfer of risk and ownership takes place (assuming the goods are paid for) once the seller has placed them at the buyer’s disposal.
FCA Free Carrier
This is the term that generally SHOULD be used when you are thinking about using EXW. In this case, the seller is obliged to organise the loading of the goods onto a truck or into a container at a specified address, as well as organise the export declaration & other formalities. eg the buyer organises a truck to pick up at your warehouse & you as the seller load the goods onto the truck. There are no problems with liability if the buyer needs to load themselves. As with all the other terms, it’s important to make sure that the delivery point is specified in as much detail as possible as this is when the risk hands over to the buyer.
As the seller is responsible for organising the export formalities, it’s important to consider whether any taxes are due at the time of export or whether pre-shipment inspections are necessary for the country of destination as those fall on the seller’s costs. If you need SGS or a similar organisation to check the goods before they leave your factory or warehouse, you will have to pay for this under the FCA terms.
CPT Carriage Paid To
In this clause, the seller hands the goods over to a carrier who delivers the goods to an agreed destination. Here is where the Incoterms® 2020 can get a bit more complicated as the hand over of risk and the obligation to cover costs take place in 2 different locations. eg a seller in Germany agrees CPT Southampton for a UK delivery. The risk for this delivery passes to the buyer when the goods are delivered to the carrier at a location in Germany, however the seller has to pay the cost of transporting the goods to Southampton.
This split in the risk and cost transfer is also the issue with the other C clauses (CIP, CFR, CIF).
The seller is obliged to organise and pay for the export formalities but not for any of the import processes or licences. The seller also has to carry the cost of unloading the goods at the named place of destination.
CIP Carriage & Insurance Paid To
As with CPT above, the same general points apply. The goods are considered to be “delivered” and the risk handed over to the buyer when the seller hands the goods over to the first carrier. However the costs for carriage and for a minimal level of insurance have to be paid to the named destination. Compared to previous versions of the Incoterms®, CIP requires a slightly higher level of insurance than CIF (CIF is used more for commodities). Export declarations or other formalities as well as the costs of unloading at the destination (but not import formalities) have to be paid by the seller.
DAP Delivered at Place
The seller delivers when the goods are placed at the disposal of the buyer at the named destination. Risks and costs are born by the seller until this point. As with the previous clauses, the seller has to organise and pay for export formalities, however not for the unloading of the goods at the location of the destination.
DPU Delivered at Place Unloaded
As with DAP, the risks and costs pass from seller to buyer at the named place of destination. In this case however, the seller also has to pay for the goods to be unloaded from the final mode of transport. The seller is not responsible for any import formalities.
This is a new clause until Incoterms® 2020 & replaces DAT (Delivered at Terminal) from Incoterms® 2010. It can get difficult if demurrage charges are incurred because the buyer causes delays to customs clearance – ideally you should consider within your sales contract how this eventuality should be managed.
DDP Delivered Duty Paid
This variant represents the maximum form of obligation for the seller, as the goods are delivered at the named place by the seller. The seller takes over all costs and risks of export clearance, transport and customs and import clearance in the country of destination.
Whilst this might seem like a great idea (at least if you’re the buyer) as it’s like a “full service” delivery, it might not be as practical as it seems at first glance. It may not be that realistic for the seller to organise all the import formalities leading to delays or additional costs (& after all, costs will be factored into the product cost somehow whoever is responsible for them).
If for some reason the seller cannot obtain the necessary import licences and perform the formalities, then you need to think about choosing one of the other “D” terms.
Maritime Terms of Incoterms® 2020
These 4 terms should only be used for seafreight or transport on inland waterways. You may sometimes hear terms like FOB Istanbul airport used, but in actual fact this kind of “wrong” usage can cause you problems further down the line if anything goes wrong with the delivery.
FAS Free Alongside Ship
The seller delivers when the goods are placed alongside a ship (on a quay or barge) at the named port agreed with the buyer. Risks and costs pass to the buyer at this point. The seller is responsible for the export clearance.
Realistically speaking, if the goods are in a container, as most deliveries being transported by seafreight are, then they will be delivered to a terminal rather than to the quayside. If that is the case then you should use FCA rather than FAS as you will be handing over to the carrier.
FOB Free on Board
The seller delivers when the goods are on board the vessel which was nominated by the buyer in the named port of embarkation. The seller has to pay for the loading as well as the export formalities. Legally speaking, the point of risk transfer is when the good pass the ship’s guardrail, hence popular exam questions about cranes dropping containers that land either on deck or in the water/on the quay and who bears the liability for the goods.
In theory, the same applies here for container deliveries – in most cases you would probably hand over to a carrier in a terminal and therefore in theory FCA would be a more correct term to use. However, many exporters/importers are familiar with FOB and it’s therefore used more often than it should be. Companies in countries such as the UK or US, often use FOB as their standard shipping term and importers may be reluctant to diverge from that.
CFR Cost and Freight
This is sometimes referred to as C&F by older exporters. As with the other terms beginning with C, you need to take care because the transfer of risk and the responsibility for the costs happen at different points in the process. The risk transfers to the buyer when the goods are delivered to the carrier but the costs have to be paid to the named destination.
It can be a good option for full container loads (FCL) but usually CPT is a better option. CFR is more recommended for bulk cargo than for container traffic.
CIF Cost, Insurance and Freight
Like CFR but with the additional cost for the supplier to organise a minimal level of insurance. This is also more recommended for bulk cargo such as commodities than for container traffic.
What about older versions of the Incoterms®?
You may have contracts which specify an older version of the Incoterms®, probably 2010. With all the upheaval of 2020 in international trade, it feels rather like the new version of Incoterms® went a little bit unnoticed. You should take care to make sure that you know what is really agreed with each of these terms and which potential consequences there could be if you use outdated Incoterms®. As with any other contract term, you only have to worry about the smallest nitty gritty details when things go wrong, but by then it’s too late to correct anything & it could get expensive.
It’s Ok to use the 2010 version of Incoterms®, but I personally would recommend updating your agreements as soon as is practical, and not to use any older versions.
Tips for using the Incoterms® 2020
Always make sure that you specify which version of the Incoterms® are to be used. That would then look something like this:
CIF Los Angeles Incoterms® 2020
With the multimodal terms it’s best to define the place as accurately as possible (ideally an address). In international trade, it’s always good to avoid ambiguity.
The Incoterms® 2020 do not replace your sales contract, they form a part of it and you need to think carefully about how all of the terms you have agreed work together. You don’t want to agree something which contradicts another part of your contract and is one reason why it’s so important to really know your incoterms. As I’ve said (repeatedly) in this post, it’s essential to specify Incoterms® 2020 in any contract, as the requirements eg with insurance, change slightly from 1 version to the next. Otherwise this falls under the category of “frequent mistakes in international trade”.
If a payment term of Letter of Credit (L/C) is to be agreed, then it’s advisable to use one of the “C” terms (CPT, CIP, CFR; CIF). This allows you as the seller to take control of the bill of lading (B/L). The B/L confers ownership of the goods, so is an integral part of the security offered by an L/C payment. When the buyer pays for the goods then the B/L is handed over to him allowing him to claim his goods.
You should know which Incoterms® are most suitable for the kinds of deliveries that you intend to make. Often freight forwarders will tell you that they generally work with just 1 or 2 standard terms but these may not be suitable or correct. This can lead to confusion between seller and buyer and that can lead to arguments and dissatisfaction. If you have a global supply chain manager they should help you with the nitty gritty, but they can’t always be by your side in customer meetings.
The final reason I want to mention for you to really know your incoterms® is that you really need to know which costs you are responsible for, before you (as a seller) make your final quotes to the buyer. If you don’t know what your responsibilities will be under the terms agreed, you don’t know which costs to expect. Pricing is an art and science in itself so you should consider whether you want to have the transparency of a fairly minimal Incoterm like FCA or to work with DDP at the other end of the spectrum where changes in the oil prices, war breaking out en route or piracy concerns can soon eat up your profits.
My personal recommendation would be (for container goods) to stick with the multimodal terms as far as possible. Remember to keep an eye open for updates in 2029!
If that all still seems like something you can’t get your brain round right now, reach out for an informal chat. You don’t necessarily need to know all of the terms in 100% detail, but as with many other “technical points” of international trade, it’s worth having an overview of the main issues and for you to know WHY you use the terms you do. (“Because we’ve always done it that way” is seldom a great justification for anything in business).
You can download an infographic with all the sections included above
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