In this article, we explained incoterms, the importance, the structure, the component, we also talked about tips for using incoterms effectively, the challenges.
Definition
Incoterms are a set of internationally standardized rules, and that define the responsibilities, costs, and risks of buyers and sellers in the shipment of goods. They are used in sales contracts to clarify obligations like who pays for transport, who arranges insurance, and when the risk of loss or damage transfers from the seller to the buyer.
Features of Incoterms
Clarify responsibilities: Incoterms clearly outline the duties of both the buyer and seller for tasks such as loading and unloading, arranging carriage, and completing customs formalities.
Define cost allocation: They specify which party is responsible for each cost incurred during the shipping process, including freight, insurance, and duties.
Determine risk transfer: Each term precisely defines the point in the shipping process where the risk of loss or damage to the goods transfers from the seller to the buyer.
Standardized and flexible: Incoterms are a globally accepted set of rules published by the International Chamber of Commerce (ICC) that are periodically updated to reflect changes in trade practices and technology.
Provide clear logistics framework: By defining a clear framework for transportation, they help businesses improve logistics planning and efficiency.
Improve communication: They serve as a common language for international trade partners, leading to better communication and a clearer understanding of the transaction.
Minimize disputes: By clearly defining obligations, they reduce the potential for misunderstandings and legal conflicts between parties.
The Importance of Incoterms:
Prevent disputes: Incoterms provide a globally recognized legal framework that clearly defines rights and obligations, reducing the likelihood of legal action and misunderstandings.
Clarify roles: They specify who pays for and manages activities such as shipment, insurance, and customs clearance, ensuring there is no ambiguity about each party’s duties.
Manage risk: The rules clearly state when the risk of loss or damage to goods transfers from the seller to the buyer, helping with risk management and insurance responsibilities.
Allocate costs: Incoterms determine how costs are divided between the buyer and seller, helping companies avoid unexpected charges and manage budgets effectively.
Promote efficiency: By standardizing processes and responsibilities, Incoterms make international trade more efficient and easier to conduct across different legal and business systems.
Aid in decision-making: A clear understanding of Incoterms empowers supply chain and logistics professionals to make better-informed decisions that impact profitability and operational efficiency.
The Structure of Incoterms:
Structure by mode of transport
Any mode of transport: These terms can be used for air, sea, road, or rail.
Group E: EXW (Ex Works)
Group F: FCA (Free Carrier)
Group C: CPT (Carriage Paid To), CIP (Carriage and Insurance Paid To)
Group D: DAP (Delivered at Place), DPU (Delivered at Place Unloaded), DDP (Delivered Duty Paid)
Sea and inland waterway transport: These terms are exclusive to these specific transport methods.
FAS (Free Alongside Ship)
FOB (Free on Board)
CFR (Cost and Freight)
CIF (Cost, Insurance, and Freight)
Structure by seller responsibility
The terms are also structured to show the increasing obligations of the seller:
Group E (Minimum seller obligation): The seller’s responsibility is the least, for example, making goods available at their premises (EXW).
Group F (Seller delivers to a carrier): The seller’s responsibility is to deliver the goods to a carrier at the seller’s expense, with the buyer then bearing the costs and risks of the main transport.
Group C (Seller arranges and pays for carriage): The seller is responsible for the main carriage to a destination, but the risk transfers to the buyer when the goods are handed to the first carrier.
Group D (Maximum seller obligation): The seller is responsible for delivering the goods to the buyer at the destination, bearing the costs and risks, as in DAP (Delivered at Place) or DDP (Delivered Duty Paid).
Components of Incoterms
Delivery: The rule specifies the exact point or place where the seller has fulfilled their obligation to deliver the goods to the buyer. This point is critical as it is also usually where the risk transfers.
Transfer of Risk: This defines the precise moment (e.g., when goods are loaded onto the vessel, or made available at a terminal) when the responsibility for loss or damage to the goods passes from the seller to the buyer.
Allocation of Costs: Incoterms clearly outline which party is responsible for paying for various expenses, including transportation (pre-carriage, main carriage, and on-carriage), insurance, handling charges, and customs duties/taxes.
Documentation and Formalities: The terms indicate which party is responsible for obtaining and managing necessary documentation and carrying out customs formalities for export and/or import, such as licenses, security-related clearances, and transport documents (e.g., bill of lading).
Insurance: The rules specify which party, if any, is obligated to provide for cargo insurance coverage and the minimum level of that coverage (this is a mandatory seller’s obligation only under CIF and CIP terms).
Packaging and Checking: The seller is responsible for packaging the goods for transport in an appropriate manner for the agreed mode of transport, and for checking, marking, and counting the goods.
Tips for Using Incoterms Effectively:
Choose the right Incoterm: Select the term that best fits the mode of transport (e.g., ocean vs. any mode) and the desired distribution of costs, risks, and responsibilities. For example, consider DAP (Delivered at Place) for greater buyer control and less risk, or DDP (Delivered Duty Paid) if you want to handle all aspects up to the buyer’s location.
Check carrier support: Not all carriers support every Incoterm rule. Always check with your chosen international carrier to confirm they can accommodate the term you plan to use.
Specify the term on all documents: Include the Incoterm (e.g., “FCA, New York, Based on Incoterms® 2020 Rules”) on all relevant documents, such as sales contracts, purchase orders, and commercial invoices.
Clearly state the named place: The location in the Incoterm is critical, as it marks the point where costs and risks are transferred. Be precise and specific, like “at the named port” or “at the buyer’s location”.
Clarify risks and insurance: Understand who is responsible for insuring the goods during transit under the chosen Incoterm and ensure the correct party has adequate coverage.
Inform your customer: Don’t assume your customer understands the implications of the Incoterm. Clearly explain their responsibilities regarding costs, customs, and other logistics in plain language.
Don’t use old versions: Using outdated rules can cause confusion and legal uncertainty. Always specify the current version, such as “Incoterms® 2020 Rules”.
Be aware of what Incoterms don’t cover: Incoterms define the point of delivery, costs, and risks, but they do not cover payment terms or the transfer of title. Make sure these are addressed separately in your contract.
Be cautious with DDP: DDP (Delivered Duty Paid) places the most responsibility on the seller, including customs clearance and duties in the destination country. Be cautious with this term and ensure you are prepared to handle these obligations.
Challenges of Incoterms:
Misunderstanding risk vs. ownership: A major point of confusion is that Incoterms only define when the risk of loss or damage transfers, not when the ownership of the goods transfers. This can lead to disputes if goods are damaged.
Differing preferences: Buyers and sellers often have different preferences for Incoterms that align with their own strategic goals, leading to difficult negotiations.
Failure to specify delivery points: Not being specific enough about the delivery location allows the seller to choose a point within a general area, which may cause inconvenience or extra costs for the buyer.
Incorrectly assigning responsibilities: Misunderstanding who is responsible for customs clearance, export/import duties, and other charges can lead to unexpected costs and delays.
Scope of responsibility: Incoterms define specific aspects of shipping but do not cover other crucial elements like product specifications, quality standards, or payment terms, which must be explicitly defined in the sales contract.
National regulatory barriers: Different countries may have specific laws that conflict with standard Incoterms rules, creating unique challenges for a particular transaction. For example, a seller may be legally barred from handling export clearance in a certain country, even if an Incoterm suggests they should.
Choosing outdated terms: Using a previous version of Incoterms instead of the most current one can cause confusion and legal issues because the terms are regularly updated to reflect changes in global trade.
Conclusion
Incoterms are a set of pre-defined three-letter commercial terms published by the International Chamber of Commerce (ICC) that are widely used in international (and sometimes domestic) sales contracts. Their primary purpose is to clearly communicate the responsibilities, costs, and risks associated with the delivery of goods from the seller to the buyer.