International trade is a fundamental activity for the global economy, but it also involves a series of complexities. One of the primary sources of confusion in international transactions is the lack of clarity regarding each party’s responsibilities, especially when it comes to the delivery of goods. The Incoterms (International Commercial Terms) are a vital tool for clearly defining the obligations, costs, and risks associated with the shipment and delivery of goods in global transactions.
The International Chamber of Commerce (ICC) created the Incoterms in 1936 to provide a standardized set of rules that would reduce misunderstandings in commercial transactions. These terms have been revised multiple times to keep up with changes in international trade, with the latest version being 2020. This guide will explore in detail what Incoterms are, how they work, and how they can help you conduct more efficient and secure business.
What are The Incoterms?
Incoterms (International Commercial Terms) are a series of international commercial terms that define the responsibilities of the buyer and seller in international trade. They are globally recognized and accepted and are used to clarify who is responsible for what, from the point of origin to the final destination of the goods.
Who creates and regulates the Incoterms?
The International Chamber of Commerce (ICC) is responsible for creating and updating the Incoterms. The ICC is a global organization that promotes international trade and provides rules and guidelines that facilitate cross-border trade.
What problems do Incoterms solve?
Incoterms address key issues in international transactions, such as:
- Who is responsible for the costs of transportation and insurance.
- Where the risk of loss or damage to goods is transferred.
- Who handles customs clearance and pays duties.
How do the Incoterms work?
Each Incoterm specifies the responsibilities of the buyer and the seller in a commercial transaction. This includes where and when the risk shifts from the seller to the buyer and who is responsible for paying transportation costs, insurance, duties, and other expenses.
Importance of The Incoterms in International Trade
Incoterms play an essential role in international trade, as they establish a common language for global transactions. By clearly defining the responsibilities of both parties in a transaction, Incoterms help prevent misunderstandings and avoid legal conflicts that could arise due to a lack of clarity in shipping and delivery terms.
Benefits of Incoterms:
- Risk reduction: Specifying when the risk transfers from the seller to the buyer minimizes disputes in case of damage to goods.
- Clarity in costs: They help avoid surprises regarding transportation costs, customs duties, or insurance by clearly defining responsibilities.
- Standardization: They provide a universally accepted framework that facilitates transactions between businesses from different countries and cultures.
- Efficiency: They accelerate commercial negotiations by providing internationally recognized standardized terms.
Incoterms 2020: Updates and Key Changes
The latest version of the Incoterms, Incoterms 2020, introduced several significant changes compared to the previous version of 2010. These adjustments reflect the evolution of international trade and new logistics practices.
Key changes in Incoterms 2020:
- DPU (Delivered at Place Unloaded): Replaces the old DAT (Delivered at Terminal), allowing goods to be delivered at any agreed location, not just a terminal.
- CIP (Carriage and Insurance Paid To): Now requires the seller to arrange a broader insurance coverage than the previous version.
- Flexibility with FCA (Free Carrier): It has been clarified that parties can agree that shipping documents are issued after goods have been loaded onto the vessel.
- Greater clarity in multimodal transport: The 2020 version better addresses the use of multiple transportation methods in a single transaction, offering greater versatility in applying terms.
Classification of Incoterms
Incoterms are divided into two main categories based on the type of transport used:
1. Incoterms applicable to any mode of transport:
- EXW (Ex Works/At Factory): The seller makes goods available at their premises. The buyer assumes all risks and costs from that point forward.
- FCA (Free Carrier): The seller delivers the goods to the buyer’s carrier at an agreed location. The risk transfers when the carrier takes possession.
- CPT (Carriage Paid To): The seller pays for the transport to the agreed destination, but risk transfers to the buyer when goods are handed over to the carrier.
- CIP (Carriage and Insurance Paid To): Similar to CPT, but the seller also arranges insurance.
- DAP (Delivered at Place): The seller handles all transportation costs until the destination, excluding unloading.
- DPU (Delivered at Place Unloaded): The seller is responsible for delivering and unloading the goods at the destination.
- DDP (Delivered Duty Paid): The seller assumes all costs, including customs duties and taxes, up to delivery at the buyer’s location.
2. Incoterms exclusive to maritime transport:
- FAS (Free Alongside Ship): The seller places the goods alongside the ship at the port of shipment. Risk transfers once the goods are placed next to the ship.
- FOB (Free on Board): The seller delivers the goods when they are loaded onto the ship.
- CFR (Cost and Freight): The seller pays for transport to the destination port, but risk transfers when goods are on board.
- CIF (Cost, Insurance, and Freight): Like CFR, but the seller also arranges insurance for the goods during transport.
Detailed Explanation of Each The Incoterm
Below is an explanation of the Incoterms included in the 2020 version:
Incoterms for Any Mode of Transport:
- EXW (Ex Works/At Factory):
- Seller’s responsibilities: Make goods available at the seller’s premises.
- Buyer’s responsibilities: All costs and risks from that point forward, including transport and customs clearance.
- FCA (Free Carrier):
- Seller’s responsibilities: Deliver goods to the carrier at an agreed-upon location.
- Buyer’s responsibilities: Risk and costs transfer when the goods are delivered to the carrier.
- CPT (Carriage Paid To):
- Seller’s responsibilities: Pay for transport to the agreed destination.
- Buyer’s responsibilities: Assumes risk at the moment the goods are handed to the transport carrier.
- CIP (Carriage and Insurance Paid To):
- Seller’s responsibilities: Pay for transport and insurance to the destination.
- Buyer’s responsibilities: Assumes risks when goods are handed over to the transport carrier.
- DAP (Delivered at Place):
- Seller’s responsibilities: Pay for costs up to the destination without unloading.
- Buyer’s responsibilities: Assumes risk at the moment goods are ready for unloading.
- DPU (Delivered at Place Unloaded):
- Seller’s responsibilities: Delivery and unloading at destination.
- Buyer’s responsibilities: Takes risk after unloading.
- DDP (Delivered Duty Paid):
- Seller’s responsibilities: All costs (including duties and taxes) until delivery.
Responsibilities of the Buyer and Seller Under Each Incoterm
The table below summarizes the key responsibilities of each party under the most common Incoterms used in international trade:
How to Choose the Right Incoterm for Your Business
Selecting the appropriate Incoterm is a strategic decision that depends on multiple factors. Key points to consider include:
- Type of Product:
Bulky or high-value goods benefit from Incoterms that include insurance, such as CIP or CIF. - Transportation Conditions:
If the buyer or seller has a cost advantage or better control over transportation, they may choose EXW or FOB. - Customs Expertise:
If the seller has expertise in navigating the destination country’s customs, they may choose DDP to provide a seamless, worry-free solution for the buyer. Otherwise, they might opt for other Incoterms with fewer customs responsibilities, like FCA.
Common Errors When Using The Incoterms
While Incoterms are designed to simplify international trade, misunderstandings and mistakes can occur if they are not fully understood. Common errors include:
- Confusion About Risk Transfer:
Costs and risks do not always transfer simultaneously. For example:- Under CIF, the seller pays for insurance and transportation, but the risk transfers to the buyer when the goods are loaded onto the ship.
- Lack of Knowledge About Local Customs:
Choosing DDP without fully understanding the destination country’s customs and tax obligations can lead to unexpected costs. - Inadequate Insurance Coverage:
While the seller must provide insurance under CIP or CIF, both parties need to agree on the exact level of coverage. Often, the provided insurance does not fully cover the value of the goods, which can create problems if loss or damage occurs.
