Incoterms were developed and published by the International Chambers of Commerce (ICC) in 2009. Incoterms are the internationally identifiable acronyms used to establish the precise nature of the relationship between seller and buyer in any commercial transaction. These phrases are an efficient way of communicating the specific responsibilities assigned to each party wherever a transaction involves the transportation of goods. For example, incoterms outline who is obliged to cover the cost of each part of the international journey, who is responsible for the shipment at each part of the international journey, and who must ensure the goods are insured. Incoterms also determine what documentation is required for the transaction.
What are the types of incoterms?
Currently, there are 11 different incoterms. Each type is divided into four groups: E, F, C and D. These categories are determined by the delivery location and who is responsible for covering the cost of each part of the journey. The groups are then split into sub-categories which refer to various scenarios. When choosing an incoterm, buyers and sellers should thoroughly review each incoterm and decide which set of terms best suit them and their shipment.
Incoterms Group E - EXW (Ex Works)
Ex Works places most of the responsibility onto the buyer. The seller ensures the goods are at the seller's premises or another named location where the buyer loads and clears the goods for export.
Incoterms Group F
In this group, the seller is responsible for delivering the goods to the buyer's pre-agreed method of transportation. After this, the buyer takes responsibility for all the costs and risks. There are a couple of sub-groups in the F category of incoterms, including:
- Free Carrier (FCA): This is similar to Ex Works. The seller delivers goods either to the carrier, a nominated person at the seller's premises, or another named location. The point at which any risks are passed onto the buyer must be clearly stated.
- Free Alongside Ship (FAS): FAS is when the seller delivers goods alongside a vessel nominated by the buyer. The responsibility lies with the buyer once the goods are alongside the vessel.
- Free on Board (FOB): FOB is when the seller delivers goods on-board a vessel nominated by the buyer. The responsibility lies with the buyer once the goods are on-board the vessel. Both FAS and FOB are incoterms used for waterway shipments.
Incoterms Group C
In this group, the seller bears responsibility for all costs to the destination port. Once the goods are loaded onto the transport, the risks are transferred to the buyer. Group C incoterms include:
- Cost and Freight (CFR): CFR is similar to FOB. The difference is that the seller must pay for the costs and freight to deliver goods to their destination.
- Cost, Insurance and Freight (CIF): CIF is similar to CFR. The difference is that the seller arranges insurance cover against the buyer's risk of loss or damage. Both of these terms relate to waterway shipments.
- Carriage Paid To (CPT): In this case, the seller is responsible for arranging the transportation of the goods to a named destination, but not for insuring them.
- Carriage and Insurance Paid To (CIP): This is similar to CPT, except the seller is also responsible for insuring the goods.
Incoterms Group D
These terms relate to the destination of goods:
- Delivered at Terminal (DAT): DAT is when the seller delivers the goods to a named place of destination, once the goods have been unloaded. The seller has full responsibility for the goods up until the named place of destination.
- Delivered at Place (DAP): DAP is when the seller delivers the goods ready for unloading at the named place of destination. The seller has full responsibility for the goods up to the named place of destination.
- Delivered Duty Paid (DDP): This is for when the seller is responsible for all costs and risks relating to the delivery of goods to the buyer's named place of destination. This includes clearing goods for export and import, paying any duty and carrying out customs formalities.
Which incoterm should you choose?
Free Carrier (FCA) and Delivered at Place (DAP) incoterms are popular incoterms as they can be used for both domestic and international shipments and for any mode of transport. The seller is responsible for export customs and the buyer is responsible for import customs. In contrast, using Ex Works (EXW) places full responsibility onto the buyer, which poses the risk of the buyer not being able to carry out all of these responsibilities.
You can carry out a cost/benefit analysis to help you decide which incoterm to use. This might enable you to identify any tax or other financial benefits available for the transaction. It's also worth checking there are no legal issues that could cause problems with a shipment reaching its destination. For example, there might be country-specific restrictions on your goods if they're prohibited. It's incredibly important to ensure you have all the necessary documentation, including licences or permits.
Shipments can face problems without the correct incoterm so it's really important to think carefully about which one is appropriate. Failure to understand incoterm definitions leads to problems throughout the supply chain. For example, logistics costs could increase, the terms may not match the requirements of the buyer or seller or the buyer or seller may not be able to comply with the incoterm.
How will incoterms change?
As the current set of incoterms are over ten years old, they're due to be updated on January 2020. There is much speculation surrounding the extent to which the terms will be removed or revised, or if any new incoterms will be introduced. It's been suggested that some incoterms, such as DDP and FCA, will be split into separate terms. The new publication should also make the incoterms easier to understand, which will hopefully reduce the risk of misinterpretation.