What are Terms of Sale and why should I use them and what are the different types of Incoterm?
This post will cover:
- EXW EX Works
- FCA free Carrier
- FOB Free On Board
- CFR Cost and Freight
- CIF Cost Insurance & Freight
- DAP Delivered at Place
- DDP Delivered Duty Paid
- Incoterm FAQ
Terms of sale, properly know as ‘Incoterms ‘ are published by the International Chamber of Commerce and are widely recognised in law, worldwide. In this article we answer the question what does ‘incoterm’ mean in shipping?
The objective of Incoterms being to provide clarity and reduce or remove any uncertainties regarding international trade worldwide. To make their use as easy as possible each incoterm is given a 3 letter code.
Unlike domestic deliveries, where the delivery fee is paid for by the supplier, or perhaps you arrange collection yourself, international trade means there are many more steps, processes and factors.
For example customs clearance that need to be defined so that it is clear who has responsibility and pays for all the processes involved in sending goods internationally. Miss-understandings or disagreements over who is responsible and / or who should pay lead to disputes, and potentially shipments getting stuck in transit with important steps such as customs clearance not being arranged or disputed, sometimes leading to large additional and avoidable costs.
We will focus on the Incoterms in common use rather than cover all possible incoterms and view from an import perspective:
EXW Ex works
Your supplier’s responsibility is to make your shipment ready for collection at their premises or in theory wherever they choose
FCA Free Carrier
Similar to ex works but your supplier has to get your shipment to a named place of delivery, normally a port or airport. Note that whether export customs clearance is being paid by your supplier or not needs to be agreed (normally it isn’t).
Your supplier is responsible for all charges up to and including loading on the ship or plane. All charges once loaded, including freight, any associated surcharges and insurance are the responsibility of the customer. This term is used for about 85% of general cargo.
CFR Cost and Freight
The supplier is responsible for all costs up to the named port of destination. Note that once loaded the customer becomes responsible for goods. This means if the ship were to sink or any damage were to happen it is the customer who bears the risk and so should either insure the goods or ‘self-insure’ See the FAQ on this term below
CIF Cost Insurance & Freight
Similar to CFR but the supplier insurers the goods while in transit. Insurance should be in accordance with Institute Cargo Clause A ( this is all risks cover). See the FAQ on this term below
DAP Delivered at Place
Supplier arranges delivery to the customer’s door (the delivery address should be specified and agreed) but anything to do with arranging customs clearance is the customer’s responsibility.
DDP Delivered Duty Paid
Similar to DAP but supplier pays for customs clearance and associated charges plus also customs duty. Import VAT is normally always paid by the customer.
Freight collect Incoterms – what’s this
This is not an Incoterm at all. It might be OK to state if you have sold domestically and your customer is going to collect from you.
Internationally use this at your peril. This is one of the reasons that companies take the view that international trade seems to be fraught with difficulty. It will seem difficult if the various rules and procedures governing international trade that are in place are all ignored and you do your own thing.
If you are lucky and you have a supplier who has worked out you are not familiar with trading internationally, is kind and allows for your lack of knowledge and does not take advantage you may be OK.
It could can go the other way with your supplier spotting an angle and exploiting your lack of knowledge and you may end up paying a lot more money than you need, as well as have what you have bought delayed in transit as per the example below. Sadly this is a common occurrence.
Freight prepaid Incoterms
This also is not an incoterm at all. You will have all the same issues as the freight collect incoterm detailed above.
Freight prepaid to where for example? Your door? To the docks? A European distribution warehouse in Rotterdam? We’ve seen them all. In addition, freight may not include handling charges or customs clearance and you may have a lot of additional charges – more than the whole freight bill and that will come as an unpleasant surprise.
My supplier will only agree to ex works, what are risks?
Ex Works is not so popular, as your supplier may impose costs you may not anticipate such as a timed collection, or a self-loading truck, all extras being for the customer’s (your) account.
In addition there’s another often overlooked risk. In China, along with several other countries, anything leaving the country needs an export licence. If you buy Ex Works, your supplier may not participate on the export clearance process and that would mean you would not be able to obtain a Chinese export licence, as they are only issued to Chinese companies. That would mean you become the owner of products that can then never leave China – you wouldn’t be the first company with this dilemma and you would not be the last!
My supplier is reluctant to give me an FOB price – why?
Sometimes it is not in their interests to do so – see the FAQ on CFR terms in the next question. Most reputable suppliers in China will give to a price on FOB terms as this is how most business to business trade sent by sea is sold – probably about 85%.
I have got a price a UK port, my supplier says the terms are therefore CFR / CIF any UK port I want – sounds great as all I pay for is Clearance & UK delivery, but you say major importers buy FOB?
You are probably thinking that all have to do is arrange the clearance and arrange a local delivery, both of which are not that much money and you don’t have to worry about getting what’s ordered to the UK – so nice and easy & cheap.
Whilst this sounds very appealing, you may very well fall into a trap!
Your shipment will arrive at a UK port OK but you won’t realise but what you will invariably find out hard way is that you will then be subjected to some extortionate handling and sundry charges that you will have to pay to get release of your shipment.
It is important to understand the scam to understand why this happens. Freight sold in the Far East in particular is sold ‘free freight’. Your supplier pays absolutely nothing and we hear some companies even pay commission to shippers.
The ‘free freight’ is then recovered by an associate company in the UK, charging extortionate handling fees – sometimes thousands of pounds on a shipment, some of which is passed back to the freight company where the booking was made.
Human nature being what it is, if there’s a gravy train running, everyone tends to jump on board and make a lot of easy money. Bear in mind you’re an end user not a customer in these circumstances.
Your supplier may feel that this is risky for them as they may get additional charges they’re not anticipating.
Many companies in China, the Far East and also India will refuse to quote on these terms.
You may for example not promptly or properly arrange the customs clearance and as free times at ports are measured in days and are deliberately expensive it could be costly.
With DDP terms, whilst customs clearance is included, you may refuse to participate in the process, which in the UK is mandatory and could again lead to delays, or worse – customs deciding the goods cannot be cleared into the UK and must therefore be returned to where they came from.
What is the best Incoterms for a seller?
When selling, it is our view is that it is best to sell on CIF terms named port as agreed with your customer. Our reasons are that it gives you the greatest level of control of your own shipment.
In our view this is a good thing, If the worst were to happen you will be fully insured, assuming you have arranged insurance! And why wouldn’t you as premiums are normally tiny. It is a mystery to us why companies would sell CFR.
A customer could buy a policy that’s so poor it’s useless, or worse not insure at all, they could try and blame you, especially if there is a claim for damage.
What are the most recent Incoterms?
There is a revision of Incoterms for 2020. The most recent change being that there is a new term ‘DPU’ – Delivered Place Unloaded.
This is very similar to DAP, as noted above but obliges the buyer to unload the goods on delivery.
We think that for general cargo this is pretty pointless as we cannot imagine a scenario where a buyer does not unload cargo that is being delivered, but maybe useful for bulk loose deliveries, such as grain or sugar.