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What Are Incoterms and How to Use Them Effectively

Incoterms®.  You know the word.  You understand that these commercial selling terms are important.  But there’s still that nagging feeling: Do I really understand them well enough? And, do I even need to?

We can answer that last question. Yes, you need to be familiar enough with Incoterms to intelligently manage your company’s costs, time commitments and risks when it buys or sells goods internationally.

There are 11 Incoterms. They were developed by the International Chamber of Commerce to outline the responsibilities of buyers and sellers – basically, who pays what and when.

The “what” is the cost of transportation, insurance, customs duties and taxes. Some Incoterms put more onus on buyer to arrange and pay for transportation and related costs; some put more onus on the seller. Some represent a fairly equal sharing of responsibilities. It’s a continuum.

Let’s say you want to buy a box of peaches. You can invest the time and money to drive to the farm and pick up the peaches (little risk or transport costs for the farmer); or you can have the farmer deliver the peaches to your front door (very little risk or transport cost for you); or you could buy the peaches from the farmer’s stall at the Market halfway between your house and the farm (shared risk and transport cost).

To protect the peaches if they get dropped, you’ll pay all insurance for the farm pick up; the farmer will pay all insurance for the house delivery; and you’ll each buy insurance to cover your individual trips to and from the Farmer’s Market.

Our peach example doesn’t cover all the scenarios, but you get the idea.

You want to choose the Incoterm that aligns best with your business objective. One choice might be best to achieve the lowest possible cost. Another Incoterm would be best to minimize your time and risk. It depends on what you want to achieve and certain market conditions.

For a simple, easy-to-understand outline of each Incoterm option, refer to Dimerco’s Incoterms Chart. (Scroll to the bottom of that page to download a PDF, if you prefer).

Don’t be intimidated by all the acronyms (DDP, CIF, CFR….). Each just represents a point on a continuum of buyer-seller responsibility. It may help to refer to the chart as you read the balance of this article.

 

What are Incoterms: 9 Best Practices

Given today’s challenging market conditions, understanding and optimizing the terms of sale is more important than ever. Follow these 9 best practices to save time, avoid unnecessary freight delays and reduce your risk.

  • Take responsibility for managing your own international freight shipments. Many importers who were previously allowing the seller to route international air/ocean moves (CFR, CIF, CPT, CIP, DAP, DPU and DDP terms) are experiencing significant challenges in the current market, where freight capacity is constrained and supply chain disruptions are common. Sellers are sometimes refusing to move the goods, delaying shipments because of freight cost concerns, or up-charging buyers for additional freight costs. Even small importers may find that routing their own cargo in the current market saves time, money and customer relationships. Delegating responsibility in an international transaction can be tempting, particularly if you have a lean staff. But it may be better to control your own destiny. Importers new to freight negotiation can partner with a freight forwarder to help with the transition to a new Incoterm.
  • Control Customs clearance and final delivery. Port-related delays are rampant these days. In such an environment, you need to protect yourself from demurrage (charge for space the container takes up at the port if pickup is late), detention (charge for use of container beyond allowed free time) and storage charges. But, as a buyer, it’s hard to do that if you’re not in control of Customs clearance and final delivery, as would be the case with CPT, CIP, DAP, DPU, and DDP terms. It’s really a lose-lose scenario: You lack the control to avoid delays but, as the consignee, you’re responsible for all charges. Consider buying under terms that allow you to closely control your exposure to these unplanned expenses (FOB, for example).
  • Get internal alignment on purchase terms. Often, the Purchasing Department will decide on the term of sale without truly understanding the logistics and compliance implications of that decision. Organize a cross-functional team to set standard Incoterms for your company’s international purchases. Ensuring alignment between compliance, logistics, sales and purchasing teams avoids unanticipated costs, delays and lower-than-expected margins on customer sales.
  • Be clear about payment terms in your purchase order. Many buyers assume that Incoterms cover the method or timing of payments, or when title or ownership of the goods passes from seller to buyer. This is not the case. One common misconception is that Incoterms are the contract between buyer and seller and that, if you buy FOB (Free On Board), title to the goods transfers when those goods are on board the vessel. Incoterms only establish who pays what and when, and who assumes the risk. Be sure to cover payment terms and ownership transfer clearly in your purchase order.
  • Understand who is obligated to insure the goods while in-transit. Be sure your company has proper cargo insurance to cover your risk. A seller working under CIF terms (Cost, Insurance and Freight), for instance, is obligated to insure the goods to the destination port, but may not purchase coverage commensurate with the cost of the goods. Don’t make assumptions that your risk is covered.
  • Specify the port or place when opting for terms like DAP (Delivered at Place). “DAP New York,” for example, refers to a very wide area.
  • Be cautious before selecting DDP terms (Delivered Duty Paid). Under this term, the seller is responsible for international shipping, customs clearance, duty payments and local delivery at destination. Global trade compliance and dealing with Customs requires expertise. Think through whether the seller can satisfy all import formalities. Likewise, opting for EXW (Ex Works) makes you, the buyer, responsible for picking up freight and all export procedures at origin. Do you have the expertise and resources to manage this process thousands of miles away?
  • Think through all paperwork requirements. If the term of sale puts the onus on you, the importer, to clear customs, specify which documents must be provided by the seller to facilitate export and import procedures. Let’s say a pair of shoes requires a special Fish and Wildlife certificate. Make sure the seller provides this certificate so you can clear Customs without delay. If you overlook this step, you could find yourself paying for goods you can’t get your hands on.
  • Use a checklist to spell out the details associated with the agreed term of sale. Incoterms are handy abbreviations, but it’s wise to detail which party is responsible for each cost and compliance element. This way, there’s no room for confusion. It ensures that both parties will be satisfied with the transaction, setting a solid foundation for future sales. Lack of consistency and clarity can result in higher costs, delays and, in some cases, both the buyer and the seller paying for the same charges (it happens!).

 

Leverage Incoterms to Achieve a Competitive Advantage

What are Incoterms?

Well, they can be viewed as a rarely understood, necessary evil in international transactions. Or, when practically applied, they can be a strategic advantage for best-in-class importers and exporters.

A basic understanding is all that’s needed to make Incoterms work for your supply chain.

Contact us to learn how your business can leverage Incoterms to save time, money and reduce risk. Managing Incoterms in advance, through a clearly communicated, company-wide policy, is the best way to ensure your company is controlling costs and optimizing margins.