Using Incoterms to Simplify Global Sourcing
Specifying standard trade terms in international sales contracts lets shippers take shipment transport cost and risk responsibility in hand when it benefits them most.
Speed is vital to global sourcing and shipping operations, but it requires planning and preparation. Inadequate preparation is the most preventable—and costly—cause of shipping inefficiency. Planning for all the contingencies that impact global sourcing, particularly contract terms, is essential.
Companies that still use the contract terms prevalent decades ago are missing the opportunity to improve supply chain performance by using International Commercial Terms (Incoterms) 2010. Published by the International Chamber of Commerce, these internationally accepted trade term definitions are used worldwide in global and domestic sales contracts.
Incoterms help avoid the confusion created by varied interpretations of the rules in different countries. They specify the exporting seller's and importing buyer's obligations regarding carriage, risk, and costs, and establish basic transport and delivery terms.
Contrary to conventional perception, Incoterms only define contractual rights for risk and responsibility. Both the buyer and seller must separately specify where ownership and title transfer.
The 11 rules presented in the 2010 revision of Incoterms comprise four groups: C, D, E, and F. A three-letter code starting with one of the four group-signifying letters represents each rule.
Inexperienced and small-scale importers generally specify Group C Incoterms, under which the seller arranges and pays for shipping without assuming its risk. Sophisticated importers, however, prefer to use Group F terms, such as the Free on Board (FOB) rule.
Charges Versus Savings
Importers who are unfamiliar with the implications of Group C Incoterms, such as Cost, Insurance, and Freight (CIF)—which designates that the seller pays all cost, insurance, and freight charges—may believe these terms are more convenient because everything is included in the final price. This arrangement complicates verifying freight and insurance charges, however, and can put the shipper at a disadvantage.
Carriers typically build additional freight charges into their rates to cover insurance, currency fluctuations, and shipping risks—most of which are rarely itemized for the importer. As a result, importers often pay a higher price when the seller chooses the freight company.
Deferring ownership can delay accounting for costly shipments as inventory, which reduces expenses and boosts reported income.
Even large companies that source globally do not realize how much flexibility they have to determine how and when title transfer for imported goods will occur. Structuring contracts of sale to use Incoterms Group F—under which importers pay for shipping—allows importers to control, manage, and track their shipments themselves, while allowing them to delay the point at which they record the goods into their inventory.
Increased supply chain visibility and import shipment control are critical FOB benefits. By taking control as cargo crosses the ship's rail at the port of origin, importers gain better supply chain shipment management.
It's critical to understand that Incoterms do not cover when goods ownership or title transfer, or other considerations necessary for a complete sale contract. Title transfer is separately agreed upon between the parties in the contract of sale under applicable law.
Importers from any industry can specify in their contracts that title to the goods does not transfer from the seller until the importer takes possession at a specified point, even when paying freight costs for the imports being sourced.
Deferring ownership can delay accounting for costly shipments as inventory, which reduces expenses and boosts reported income. The sales contract can provide for supplier invoicing upon confirmed arrival at the destination port.
An online tracking system provides real-time cross-checking and shipment timing, a huge advantage in making such arrangements work.
Better Bills of Lading
Electronic tracking also greatly simplifies managing bills of lading, which show where and from whom goods are received, describe the shipment, and define carrier liability. These documents typically carry voluminous terms and conditions that contain clauses addressing exoneration, benefit of insurance, and limitation of liability. These clauses effectively limit insurance coverage, particularly if the goods are shipped using CIF Incoterms.
The new Rotterdam Rules, endorsed by 22 countries that account for 25 percent of world trade, offer some relief. They allow liability terms to be included in individual, confidential contracts that cover door-to-door multimodal shipping.
The Rotterdam Rules clearly document responsibility and liability during the whole transport process. But they are complex, and leave shippers with the problem of negotiating insurance terms.
Importers can ensure adequate insurance coverage by using FOB Incoterms, which provide control over shipping terms and insurance coverage. Electronic tracking systems with trace-back capability make FOB shipment easy by documenting bills of lading, ensuring customs compliance, and reducing insurance risks—from vessel contracting to trip closure, with storage and shipment in between.
The key to effectiveness is the freight forwarder's Incoterms knowledge. It should have a demonstrated ability to define the exporting seller's and importing buyer's obligations regarding carriage, risk, and costs, and to establish advantageous transport and delivery terms.
A comprehensive strategy for insurance, security, and contract integration, founded on sophisticated global shipment tracking technology, can enable importers to realize a substantial competitive advantage.
Simon Kaye is founder and CEO of Jaguar Freight Services.