What are Incoterms?
Incoterms, short for International Commercial Terms, are three-letter trade terms established by the International Chamber of Commerce to facilitate cross-border trade.
The latest edition is the Incoterms 2010, which consists of a total of 11 Incoterms aimed to guide buyers and sellers with the shipment process by determining the responsibilities of each party during each leg of the transportation.
Here’s a breakdown of the four Incoterm groups.
Incoterm groups
Incoterms Group C
Condition: The seller bears all costs to the destination port (including international transport) however, risk transfer will be made once the goods are loaded on the means of transport.
Incoterms Group D
Condition: The seller bears all risks and costs necessary to bring the goods to the destination country.
Incoterms Group E
Condition: The buyer is responsible for collecting the goods at the seller’s warehouse and bears all associated risk and cost.
Incoterms Group F
Condition: The seller is responsible for bringing the goods to the buyer’s predefined transport medium; the buyer then accepts cost and risk responsibility from that point onwards.
These are sorted into four different groups, C, D, E, and F, which are categorized according to the delivery location of the goods and the responsibility for payment at different stages of the international transport.
To find out more about what each Incoterm entails, we recommend you to give our page on Incoterms meanings a read.
What to consider when choosing an Incoterm
Choosing the Incoterm that best suits your ocean freight needs can be challenging, especially as a novice or first-time shipper.
From international shipping costs and responsibilities to customs clearance and duties payment, there are many factors to keep in mind.
Here are some practical considerations when choosing an Incoterm.
Mode of transport
Not all Incoterms are suitable for all international shipments, and depending on your mode of transport, you may have to opt for one over another.
Here’s a quick breakdown of the transportation modes and their corresponding Incoterms.
These are Incoterms that can be used for multimodal transportation. I.e. a combination of at least two modes of transportation, be it maritime, air, road, rail, etc.
- EXW (Ex Works)
- FCA (Free Carrier)
- CPT (Carriage Paid To)
- CIP (Carriage and Insurance Paid to)
- DAT (Delivered At Terminal)
- DAP (Delivered At Place)
- DDP (Delivery Duty Paid)
While these maritime Incoterms are suitable only for sea or inland waterway transportation:
- FAS (Free Alongside Ship)
- CFR (Cost and Freight)
- FOB (Free On Board)
- CIF (Cost, Insurance, and Freight)
Containerized or non-containerized cargo
Another factor to consider when choosing an Incoterm is whether you will be shipping containerized or non-containerized cargo.
FOB and CIF are two of the most commonly used Incoterms in the shipping trade. But the ICC actually deems them to be inappropriate for containerized cargo and advice against using them in the container trade.
This stems from the seller not actually ‘delivering’ the container onto the shipping vessel, but instead, drops it off at an inland location or terminal. This creates a gray area in which responsibilities become unclear should the cargo get damaged or even lost when it is sitting at the terminal waiting to be loaded.
Containerized cargo remains unopened until arrival at destination. In the event a containerized shipment being mistakenly shipped under FOB or CIF arrives damaged, it is difficult to determine where and when the damage actually occurred, which could lead to an insurance and/or liability gap.
Despite the official advice from the ICC, it is still common for freight forwarders and agents around the globe to list FOB and CIF as Incoterms when shipping containerized cargo.
It is also so ingrained that despite understanding the distinction between Incoterm usage for containerized and non-containerized cargo, many industry players continue to refer to FCA as FOB, CPT as CFR, and CIP as CIF when talking about containerized cargo.
If you’re shipping containerized cargo, make sure your freight forwarder or agent lists the correct Incoterm to avoid potential complications.
How much control you want to have
The Incoterm you choose for your international shipment determines the shipment areas and phases you’re responsible for.
The general rule of thumb is, the more responsibility you have, the higher the cost for you. But this also translates to having more control over the shipment.
For example, the D Incoterms (DAP, DAT, and DDP give the seller full control over the entire process until the arrival of the merchandise at destination.
This includes arranging land transportation, ocean freight, customs at origin, shipping insurance, etc. Essentially, this means that the buyer has no decision making power over the decisions made related to the shipment when it’s at origin.
This could be problematic if, as a buyer, you need your shipment to arrive by a certain date. But since it’s up to the seller to book and pay for the ocean freight, he or she may end up booking the cheapest option, which may risk your cargo not getting in on time.
What Incoterms do not cover
Even though Incoterms are responsible for determining the rules and responsibilities of the shipment process, there are certain aspects that are beyond Incoterms.
- Property rights and title transfer of goods: Incoterms have no say over ownership and title transfer of goods. These have to be discussed by the buyer and seller and they need to arrive at an agreement on their own.
- Force majeure: These refer to unavoidable catastrophes that are beyond the buyer or seller’s control. These include natural disasters, acts of war, terrorism, civil or military disturbances, etc.
- Breach of contract: Incoterms also do not cover contract breaches (i.e. when a party fails to honor a binding agreement), be it by the buyer or seller. This is a clause that should be added to your contract.
- Terms of payment: Incoterms also do not determine how payment should be carried out between buyer and seller and do not cover non-payments. When arranging international payment, especially if doing so with a Letter of Credit, make sure that the Incoterm chosen is aligned with your bank’s requirements. This is one of the most common Incoterms mistakes.
How to choose the right incoterm
Choosing the right Incoterm for your international transaction can be a complicated process. What’s the best Incoterm for a seller? What’s the best Incoterm for a buyer?
With so much at risk, it’s a process into which you need to put much thought. The number of factors to consider can make the decision-making process rather daunting.
To fully grasp Incoterms and understand how to choose the right Incoterm, we recommend downloading our free ebook on How to choose the best incoterm. A guide for exporters and importers. In this ebook, we go through the best Incoterms for buyers and sellers, as well as the pros and cons of each Incoterm.
If you have more questions about choosing the right Incoterm, you may contact our team of specialists.
