Incoterms: The Good, The Bad, and The Ambiguous
Incoterms are a set of international rules that interpret the most commonly used trade terms. Applying Incoterms to sales and purchase contracts makes global trade easier and helps partners in different countries understand one another.
Doing business globally can be complex. With multiple stakeholders, several transportation modes often required to move a product, and customs regulations to comply with, shippers have many details to address before a shipment is loaded on a vessel.
Enter Incoterms. These rules serve as a guidebook for many aspects of global cargo transportation, but are primarily designed to address the obligations of the seller and the buyer of a shipment relative to cost and risk throughout the process leading up to cargo being loaded and while in transit.
Why Use Incoterms?
“Incoterms allow for standardized technology and eliminate the risk of inconsistencies in language terms,” says Phil Denning, vice president of U.S. sea logistics and operations for Kuehne + Nagel. “They also clearly define the cost and risk responsibilities for both the seller and the buyer, in addition to assigning responsibility for customs clearance, first- and last-mile delivery, and insurance coverage.”
The International Chamber of Commerce first published Incoterms in 1936, and update the rules approximately every five years. The most recent changes were made in 2020.
It is a good idea for shippers to regularly refresh their knowledge of Incoterms to ensure they are aware of all current changes.
Here are the most current Incoterms and what they cover.
EXW (Ex Works or Ex-Warehouse)
When goods are sold, it is the seller’s responsibility to package the goods and make them available to the buyer. The buyer is responsible for collecting the goods and all costs associated with shipping, exporting, and importing. The seller is no longer responsible for the goods once the buyer is made aware that they are ready for collection.
FCA (Free Carrier)
The seller is responsible for making the goods available at an agreed-upon location, such as a warehouse or shipping terminal. If the goods need to be moved before the international shipment, the seller is responsible for arranging and paying for the transportation and for loading the goods onto the buyer’s chosen mode of transportation.
The seller is also responsible for clearing the goods for export and paying any export charges. At this point, the buyer assumes responsibility for the goods and should provide a bill of lading to the seller once the goods are loaded for transportation.
CTP (Carriage Paid To)
The seller is responsible for packing and transporting goods to the international carrier, covering customs and export costs, and paying for international shipping.
While the seller pays for the international transport, responsibility for loss or damage transfers to the buyer once the goods have been delivered to the international carrier.
CIP (Carriage Insurance Paid To)
In addition to the items addressed in the CTP rule, the CIP Incoterm also requires the seller to pay for insurance coverage for the goods in transit. Some companies choose to require insurance to cover 110% of the value of the goods. However, the seller and buyer can agree on the specific amount of coverage for a shipment.
DAP (Delivery at Place)
This rule states that the seller is responsible for delivering the goods to an agreed-upon location, bearing all costs for exporting and transporting the goods as well as the risks during transport until the goods are delivered to the destination the buyer selects.
At this point, all responsibility transfers to the buyer including covering the costs and process of unloading the goods and paying all import duties, taxes, and customs clearance fees.
DPU (Delivery at Place Unloaded)
When cargo arrives at its destination, the seller is responsible for providing resources to unload goods for the buyer. Once all the goods have been unloaded, the buyer is responsible for import duties, taxes, and customs clearance fees.
DDP (Delivery Duty Paid)
This Incoterm makes the seller responsible for delivering the goods to the buyer. The seller is also responsible for delivering the goods to the port or shipping terminal, overseeing the goods being unloaded, paying export fees and international shipping fees at the port of origin, and ensuring the goods are cleared through customs when they arrive at the destination port.
The seller pays import and customs clearance fees, delivers the goods, and is responsible for all risks involved in the transaction to this point.
FAS (Free Alongside Ship)
The seller is responsible for all charges and risks associated with transporting the goods from their location to the ship’s loading bay. After delivery, the buyer is responsible for the risk, cost of loading the goods, and essentially everything else associated with the shipment.
FOB (Free on Board)
The seller is responsible for all risks and costs associated with transporting the goods from their location to the shipping terminal. The seller also must make sure the goods are loaded onto the ship as well as handle export clearances and associated costs.
CFR (Cost and Freight)
This Incoterm states that the seller takes responsibility for all risks and costs of transporting the goods to the international carrier, arranging for the goods to be loaded, and acquiring and paying for export clearances.
The seller is also responsible for the cost of transporting the goods to the buyer’s destination port. Responsibility only transfers to the buyer once the goods arrive at their port of destination.
CIF (Cost, Insurance, and Freight)
This Incoterm is different from CFR because it stipulates that the seller is responsible for the cost of insuring the goods when they are in transit.
Are the Rules Easy to Use?
“Incoterms are a specialized body of knowledge,” says Andy Dyer, president of transportation management for AFS Logistics. “The buyer and seller must agree to the terms, so if either party does not have the same interpretation of the rules, there can be conflicts.”
Another factor that adds to the complexity of using Incoterms is that the sales contracting process typically involves different parties within a company than the ones who will be responsible for abiding by the terms.
No one is required to use Incoterms and some companies choose not to do so. In that scenario, “It’s all good until it isn’t,” says Radhika Mulastanam, director of international services for AFS.
Many aspects of global shipping can go awry, including not having adequate labor at the port for loading and unloading cargo, late deliveries by transportation providers, or even damage to the cargo or vessel in transit.
“That is why it is important to have terms in place to navigate unexpected issues or conflicts,” says Dyer.
How Incoterms Impact Shipping Costs
When choosing Incoterms for a contract, an old adage holds true: You get what you negotiated.
For example, buying goods under the Ex-Works or (EXW) rule or the Delivered at Place Unloaded (DPU) can result in very different costs for the buyer and seller.
Another aspect that is important for sellers and buyers to analyze is the distribution of transportation costs and duties to be performed, like loading, unloading, and packaging of goods. The combined cost of trucking, ocean, and rail can have a significant impact on the overall cost of the cargo being transported.
While a seller or buyer may pay less for an international shipment based on the allocation of transportation costs, deciding which party is best prepared to organize fast, safe, and cost-efficient transportation can have impacts beyond cost savings.
The goal is that the product being shipped globally reaches the end consumer on time and is undamaged. Rules can provide a framework, but not the expertise to select the best providers to ensure cargo gets to the port of origin and is ready to be processed at the destination port.
What Global Conditions Impact Incoterms?
International shipping has had its share of challenges over the past few years, from port congestion to the war in Ukraine.
“While global unrest can result in other challenges for global shippers, it is unlikely to impact the use of Incoterms,” notes Maren Corbett, director of operational transformation for Kuehne + Nagel.
Mulastanam shares this example: “When there was a tsunami several years ago, new cars were held at a port in Japan because conditions made it physically impossible to deliver the cars. Had the tsunami occurred while the cars were still on the vessel, rather than offloaded, cost allocation would have been different, based on Incoterms.”
“The financial instability of destination countries can influence the use of Incoterms,” says Corbett. “For example, all shipments for Venezuela must move on C-terms due to currency fluctuations.”
Incoterms provide a basic framework to allocate cost, risk, and duties to global shipments. However, the terms change, can be confusing, and only apply if both the seller and buyer agree. Shippers should review the rules periodically for changes and, when in doubt, partner with a third-party provider specializing in global shipping.
Asked & Answered: Incoterms FAQs
Here are some common questions shippers have about Incoterms.
Do Incoterms apply to services as well as goods?
Primarily, Incoterms apply to goods. They are not intended for services in trade. There are some exceptions when training is included with the goods being traded. If the training materials and demonstrations are imported, Incoterms may be relevant. However, the key takeaway is that Incoterms apply to goods.
How do Incoterms work?
The terms provide a foundation for commonly negotiated global or cross-border trade aspects. When buyers and sellers agree to do business following these universal terms, they simplify the process of global trade because companies have a framework for negotiations. Customs clearance authorities also use Incoterms to establish the base for import taxes.
How do Incoterms affect the price of global transactions?
The terms define which aspects of transportation and insurance are assigned to the buyer and the seller. For example, the seller must have shipments ready for collection by the buyer. In many cases, the goods can be collected from the seller’s warehouse or distribution center.
In DDP terms, the seller must have the shipment ready for unloading at the buyer’s warehouse. Any costs incurred in transporting the goods from the seller’s location to the buyer’s location can increase the price of the transaction for the seller—the party responsible for delivering the goods to the buyer.
What do Incoterms not cover?
Many aspects of global trade are not covered by Incoterms, including title transfer, conflict resolution, the currency of payment, exchange rates, the jurisdiction of trade law, and liability on post-clearance audits.
Can Incoterms be modified by a contract?
The simple answer is yes. The terms are not laws or regulations and can be modified by the seller or buyer. However, the more significantly the contract language varies from the concepts established by Incoterms, the more difficult it can become to refer to case law or precedents in the event of a claims dispute.
Are Incoterms legally binding?
The terms are legally binding to the degree that a sales contract is legally binding. On their own, the terms are not legally binding unless they are used in a contract or agreement between sellers and buyers.
Are Incoterms required on a commercial invoice?
They are not. However, Customs may use a specific term as the basis of valuation for goods being shipped internationally. By using an Incoterm for the transaction, the seller and buyer can influence the amount of the valuation and reduce valuation challenges.
What Incoterms should be used for domestic shipments?
There is no restriction on the use of Incoterms for domestic shipments. It is important that the sales contract clearly states which aspects of the terms do not apply to a specific transaction.
Should Incoterms be used for air freight?
The terms that can be applied to air cargo are: EXW, DDP, DPU, CIP, DAP, FCA, and CPT.
When does title transfer occur in Incoterms?
Incoterms does not address the issue of title transfer. However, the rules do address the point of delivery. Some companies use the words “title transfer” and “point of delivery” interchangeably.