What INCOTERM Should I Use?

INCOTERMs are heavily relied on to distribute transportation responsibilities that is distributed between the importer and the exporter. Here is a table of what is the best possible INCOTERM for the buyer or the seller to use

 To the BuyerTo the Seller
INCOTERM with the HIGHEST RISKEx-Work or Ex-Factory (EXW)Delivery Duty Paid (DDP)
INCOTERM with the LOWEST RISKDelivery Duty Paid (DDP)Ex-Work or Ex-Factory (EXW)
INCOTERM with the HIGHEST COSTDelivery Duty Paid (DDP)Ex-Work or Ex-Factory (EXW)
INCOTERM with the LOWEST COSTEx-Work or Ex-Factory (EXW)Delivery Duty Paid (DDP)

In a business transaction between two different parties. Both the buyer and the seller would wish to maximize their own interest.

Therefore, it is a rare occurrence that a buyer is ready to take on an INCOTERM with the highest risk, and equally so for the seller.

This is why 9 other INCOTERMs are available for buyers and sellers to choose from. The 9 other INCOTERM lies within the spectrum of risk between EXW and DDP.

To determine which INCOTERM should you use, there are a few considerations that will help you decide: –

  1. Your relationship with the buyer or the seller
  2. The nature of your cargo
  3. Industry practices
  4. Mode of transportation

The more you understand the considerations above, the easier it is for you to determine which INCOTERM you should use.

In this article, we will look into those 4 considerations, showing you as well some examples to help you understand further.

But first and foremost, we must at least have a basic level understanding of what the 11 INCOTERMs are. We will explain those in brief too.

Brief Descriptions of INCOTERM 2020

What each INCOTERM means is described many times, but we are here to find out what INCOTERM should you choose for your delivery planning.

First and foremost, we need to ascertain which INCOTERM is used for which modes of transportation.

Here is a table outline for you to refer to: –

INCOTERMAbbreviationMain Mode of Transportation
Ex WorkEXWLand, Sea, Air, or a mixture of them
Free CarrierFCALand, Sea, Air, or a mixture of them
Carriage Paid ToCPTLand, Sea, Air, or a mixture of them
Carriage and Insurance Paid ToCIPLand, Sea, Air, or a mixture of them
Delivered At PlaceDAPLand, Sea, Air, or a mixture of them
Delivered at Place UnloadedDPULand, Sea, Air, or a mixture of them
Delivery Duty PaidDDPLand, Sea, Air, or a mixture of them
Free Alongside ShipFASSea Only
Free On BoardFOBSea Only
Cost and FreightCFRSea Only
Cost Insurance and FreightCIFSea Only

If the main leg of the transportation is done mainly via the sea, all of the updated 2020 INCOTERMs can be applied.

However, there are 4 distinct INCOTERMS that are exclusively sea freight based only. (FAS, FOB, CFR, and CIF).

Ex Works

Seller’s Obligation

  1. Seller delivers the ready goods at a place of the seller’s country of origin

Buyer’s Obligation

  1. Buyer names the place for the seller to deliver the ready goods
  2. Buyer loads the cargo
  3. The buyer arranges the rest of the transportation up to the buyer’s door
  4. Buyer also has to carry out any import and export custom formalities

Risk Transfer

  1. The delivery risk is transferred when the buyer loads the ready cargo onto its appointed transport.

Free Carrier

Free Carrier FCA

Seller’s Obligation

  1. The seller delivers the ready goods at a place of the seller’s country of origin.
  2. The seller loads the cargo onto the transport mode chosen by the buyer (if at seller’s premise)
  3. Seller avails the cargo for unloading at a named location (outside of seller’s premise)
  4. Seller also has to carry out any export custom formalities

Buyer’s Obligation

  1. Buyer loads the cargo
  2. The buyer arranges the rest of the transportation up to the buyer’s door
  3. Buyer also has to carry out any import custom formalities

Risk Transfer

  1. The delivery risk is transferred to the buyer at the point of delivery of a named place.

Carriage Paid To

Carriage Paid To CPT

Seller’s Obligation

  1. The delivery of goods to the appointed carrier is the responsibility of the Seller.
  2. The Seller also has to arrange a contract of carriage for the main leg of the transportation

Buyer’s Obligation

  1. Buyer has to arrange delivery from the port of destination to the buyer’s door
  2. Buyer also has to carry out any import custom formalities

Risk Transfer

  1. The risk is transferred to the buyer when the cargo is handed over to the carrier. Although the carrier is appointed by the seller, the buyer bears the risk of transportation made by the appointed carrier.

Carriage and Insurance Paid To

Carriage and Insurance Paid to CIP

Seller’s Obligation

  1. Seller is obligated to deliver the goods to the appointed carrier (any mode of transportation)
  2. The seller has to arrange a contract of carriage for the main leg of the transportation
  3. The seller has to purchase cargo insurance with a minimal cargo institute clause (C) unless otherwise specified.

Buyer’s Obligation

  1. Buyer has to arrange delivery from the port of destination to the buyer’s door
  2. Buyer also has to carry out any import custom formalities

Risk Transfer

  1. The risk is transferred to the buyer when the cargo is handed over to the carrier. Although the carrier is appointed by the seller, the buyer bears the risk of transportation made by the appointed carrier.

Delivered at Place

Delivered at Place DAP

Seller’s Obligation

  1. The seller has to deliver the goods to the seller’s chosen premises at the destination country.
  2. The seller has to avail the delivered goods for unloading.
  3. The seller has to carry out any import and export customs formalities.

Buyer’s Obligation

  1. Buyer has to take delivery of the goods at the buyer’s chosen destination premise

Risk Transfer

  1. Risk of delivery is transferred when the cargo is made available for unloading at the destination premise

Delivered at Place Unloaded

Delivered at Place Unloaded

Seller’s Obligation

  1. Seller has to deliver the goods to the seller’s chosen premise at the destination country
  2. Seller has to avail the delivered goods for unloading
  3. Seller has to carry out any import and export custom formalities
  4. Seller has to unload the delivered cargo at the seller’s chose premise

Buyer’s Obligation

  1. Buyer has to take delivery of the goods at the buyer’s chosen destination premise

Risk Transfer

  1. Risk of delivery is transferred when the cargo is successfully unloaded at the buyer’s chosen premise

Delivery Duty Paid

Delivery Duty Paid DDP INCOTERM

Seller’s Obligation

  1. Seller is responsible for all the transportation requirements (including cargo unloading) to the named destination premise of the buyer’s choice.
  2. Seller is also obligated to pay for any custom duties due to the country of destination.

Buyer’s Obligation

  1. Although buyer is not obligated to carry out custom formalities at port of destination, the buyer is obligated to provide any supporting documents (including import permits) to the seller to perform import customs clearance.

Risk Transfer

  1. The buyer does not have any risk of transportation incurred, apart from providing import supporting documents

Free Alongside Ship

FAS Free alongside Ship INCOTERM Use

Seller’s Obligation

  1. Seller is obligated to deliver the goods alongside the ship (namely a quay or a barge)
  2. Seller must perform any local export custom clearance obligations

Buyer’s Obligation

  1. Buyer has to arrange the contract of carriage of the ship
  2. Buyer has to perform import custom clearance obligations
  3. Buyer has to unload the goods at its own premise

Risk Transfer

  1. Transportation risk is transferred to the buyer when the cargo has been delivered and place alongside the ship contracted by the buyer

Free on Board

Free On Board FOB INCOTERM Use

Seller’s Obligation

  1. Seller is obligated to deliver the goods and ensure the cargo is onboard the vessel contracted by the buyer
  2. Seller must perform any local export custom clearance obligations

Buyer’s Obligation

  1. Buyer has to arrange the contract of carriage of the ship
  2. Buyer has to perform import custom clearance obligations
  3. Buyer has o unload the goods at its own premise

Risk Transfer

  1. Unlike Free Alongside Ship, the risk of transportation is transported only when the cargo is loaded onboard the vessel

Cost and Freight

Cost and Freight CFR INCOTERM Use

Seller’s Obligation

  1. Seller delivers the goods up to the buyer’s port of destination
  2. The seller arranges the sea freight
  3. The seller also performs all the required export custom formalities

Buyer’s Obligation

  1. The buyer receives the goods at the port of destination
  2. The buyer performs all import custom formalities

Risk Transfer

  1. The risk of transportation is transferred to the buyer once the vessel berths at the named port of destination

Cost Insurance and Freight

CIF Cost Insurance Freight INCOTERM USE

Seller’s Obligation

  1. Seller delivers the goods up to the buyer’s port of destination
  2. The seller arranges the sea freight
  3. The seller also performs all the required export custom formalities
  4. The seller is required to purchase cargo insurance limited to Institute Clause (C), unless otherwise specified by the terms of negotiation

Buyer’s Obligation

  1. The buyer receives the goods at the port of destination
  2. The buyer performs all import custom formalities

Risk Transfer

  1. The risk of transportation is transferred to the buyer once the vessel berths at the named port of destination

Considerations that Determine Which INCOTERM to Use

Now you have a brief guide to what each INCOTERM entails, let’s look at 2 aspects you need to consider: –

Relationship Between Buyer and Seller

This is perhaps the most important factor to consider when selecting an INCOTERM to trade with.

On the other hand, we must keep in mind that an INCOTERM only establishes logistical responsibilities between the buyer and seller only. It is by no means a substitute for a contract of sales.

To elaborate, the INCOTERM does not cover: –

  1. Cargo packaging method
  2. Payment method by the buyer to the seller
  3. Consequences for a breach of contract of sales
  4. Import/export customs requirements
  5. Intellectual property rights
  6. Cargo Specifications

Therefore, the relationship between the buyer or seller is not so much as to how trustworthy the seller is to fulfil its contract of sales, nor as to how trustworthy the buyer is to fulfil its payment obligations.

The relationship in question is, by contrast, the level of expertise the buyer or the seller has in handling the cargo’s supply chain requirements.

The seller’s invoiced price reflects the amount of transportation risk the seller is willing to bear.

In summary, the relationship between the buyer and the seller we need to quantify is: –

  1. Which party is more adept in handling the transportation.
  2. The risk/return threshold each party is comfortable with.
Fulfilment by Amazon

As an example, Amazon, the poster company that represents the e-commerce business, provides a holistic online marketing platform for small business owners.

Amazon has created a complete supply chain to deliver products for the platform business users, known as Fulfilment by Amazon (FBA).

FBA services include: –

  1. Package labelling service
  2. Repackaging service
  3. Order fulfilment
  4. Global delivery
  5. Inventory control

Amazon has neatly taken away all the supply chain woes to help small businesses expand on other more important aspects of the business.

Although this may not be an apple-to-apple example to describe how relationship between buyer and seller help determines INCOTERM, but the relationship dynamics still applies.

Amazon, as one of the most influential company in the world, would be a trustworthy partner to outsource your logistics and supply chain needs to.

In a more straight forward international trade transaction between 1 buyer and 1 seller, whoever has the experience in handling the cargo transportation may be more suitable to take on the responsibility.

Risk/Return Threshold

On the trade invoice, you would find the three most common shipping documents: –

  1. Invoice
  2. Packing List
  3. Bill of Lading

The invoices presented in an international trade always includes an INCOTERM trade term. The amount payable on the invoice will also reflect the INCOTERM term chosen.

For example, an invoiced amount quoted with DPU term would cost more than an invoiced amount quoted with EXW term.

Since the seller bears most of the costs and risks of transportation, the invoiced amount should reflect the cost and risks taken by the seller.

As part of the contract of sales, the willing buyer and willing seller determination applies. If the buyer is not willing to pay for the premium for the transportation arrangement, the buyer may be better of arranging the transportation on its own.

Transportation Mode

As we have tabled above, the 4 INCOTERMs that is applicable for sea transportation only are

  1. FAS
  2. FOB
  3. CFR
  4. CIF

So, you need to look at other INCOTERMs to apply, if your cargo is meant for other multimodal modes of transportation.

INCOTERMs can also cause some confusion when there are multiple carriers involved. The ICC guidebook made an effort to address this complexity.

CIP and CPT

“Carriage Paid To” and “Carriage and Insurance Paid To” are more commonly referred to when there are multiple modes of transportation involved. The arrangement may look something like a “road-rail-sea-road” transportation.

This would not be a problem if there is only one contract of carriage involved.

There is a clear distinction where the seller has its third-party logistics service provider perform the multimodal transportation under one contract.

therefore, you can easily determine where the risk of transportation transfer occurs.

Where there is more than one contract of carriage required to navigate a multimodal mode of transportation such as a “road-rail-sea-road” mode, both CIP and CPT can not be a reliable INCOTERM. Since it would cause confusion as to the point where the transportation risk is transferred to the buyer.

More Info

https://maxfreights.com/whats-the-difference-between-cif-and-cip/Opens in a new tab.
International Chamber of CommerceOpens in a new tab.

kelvinsee

Hello! I'm Kelvin, I work as a custom broker and I'm thrilled with having the experience to share my industry knowledge with you. I hope that you enjoy reading them as much as I do posting them.

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