Export Digest: Demystifying Incoterms
07 October 2012
The International Commercial Terms (Incoterms) are a series of commercial terms used in international commercial transactions. Each Incoterm refers to a specific type of agreement for the purchase and shipping of goods internationally and are meant reduce or eliminate uncertainties emanating from various interpretations of rules in different countries.
It is commercial suicide, when negotiating an international sales contract, to ignore Incoterms.
First published in 1936, the Incoterms have been regularly updated. The latest, Incoterms 2010 (8th version), was published on January 1, 2011 by the International Chamber of Commerce (ICC).
Export Digest has engaged Rose Blatch, an expert in export training, to demystify Incoterms.
Are you selecting FOB or CIF when you should be selling under FCA or CIP?
Understanding the ICC’s Incoterms® 2010 Rules is a critical step to achieving sustainable export success.
Nearly all those engaged in international trade will have come across the terms EXW (Ex Works), FOB (Free on Board) and CIF (Cost, Insurance and Freight) at some point. However, a surprising number of African importers and exporters are unaware that these are just three out of eleven terms that are currently in widespread use. FOB and CIF, in particular, are frequently selected when they are totally inappropriate.
Why is this so important?
It is important to understand that trade or commercial terms have evolved over the years to simplify the thorny issue of who organizes, pays for, and bears the risk for loss of, or damage to, goods while they are in transit.
Misunderstandings over the allocation of delivery-related tasks led the International Chamber of Commerce in Paris, France, to introduce standardized rules governing the obligations of each contractual party in the 1930s.
These rules were intended for universal use; however, although adopted by most of the world soon after they were first introduced, they have only in recent years, for example, replaced the American trade definitions in the USA. Since their introduction, the ICC’s rules, known as the Incoterms®, have undergone numerous revisions aimed at reducing misunderstandings and ensuring the relevance of the terms in a rapidly changing world.
Today, Incoterms® play a key role in sales contracts. Where a particular term is stated in a contract, the international rules automatically apply. These rules have been translated into all the world’s most commonly used languages and so are universally understood. Although each of the eleven terms has a name, it also has a three letter international symbol. Thus ‘Ex Works’ is depicted as EXW; ‘Free On Board’ as FOB; ‘Cost, Insurance and Freight’ as CIF, etc.
Although trade terms have been in use for almost as long as cargoes have been transported across oceans, and the standardized ICC Rules have applied since the 1930s, parties to sales transactions have often been embroiled in disputes because their understanding of their own obligations (and those of the other party) have been at odds with the expectations of their counterparts. In addition, often – and particularly in a Southern African context – incorrect terms have been used for export transactions. Although these errors may not have proved catastrophic at the time, had the cargoes concerned been subject to accident or theft while in transit, the outcomes could have been very different.
Duties of buyer/seller according to Incoterms 2010 (http://en.wikipedia.org/wiki/Incoterms)
The most frequent error is the inclusion in a contract, where delivery is to take place by road or rail, of a term intended only for goods moving along inland waterways or across oceans. The latest Revision (2010) of the Incoterms® now specifically groups the eleven terms into two categories: those terms that are used exclusively for water transport; and those that can be used for any mode of transport, including multimodal transport. The terms intended only for goods moving by sea and/inland waterway make a clear reference to the goods being ‘loaded on board the vessel’ and are always qualified by the name of a port. Hence the term appears, for example, as FOB Walvis Bay, or CIF Houston.
Under a sea freight term, the critical point at which the risk inherent in delivery passes from the seller to a buyer will always be either a port quayside, or the deck of a vessel berthed in the port. If a sea freight term is used and the goods never enter a port or get loaded on a vessel, the risk remains perpetually with the seller. Therefore, if a road hauler is involved in an accident, or a railway wagon is derailed resulting in damage to or loss of the cargo, the seller will bear the risk. This can be contrary to the expectations of a seller who believes his risk is over once the goods are loaded on the truck/wagon.
Some years ago, a Zambian exporter of copper wire to Malawi faced just such a problem. He dispatched the cargo CIF Blantyre, anticipating that he would pay the transport cost to the Malawian commercial center but would be free of risk once the road hauler had collected the consignment from his factory warehouse. Unfortunately, shortly after crossing the Zambian/Malawian border, the vehicle was involved in an accident and its load strewn across the road. Although some of the cargo was salvaged, the buyer eventually received only around 35% of his order. When he refused to pay the invoice value, the Zambian exporter threatened litigation but subsequently withdrew his case on discovering that he still carried the risk in the venture. He had no legal recourse as the cargo had not been loaded on board a vessel.
In the circumstances described above, the correct term to have used would have been CIP (Carriage and Insurance Paid to) Blantyre. Under CIP, the exporting company would have paid for the carriage, but the risk in delivery would have passed to the buyer at the time that the consignment was handed over to the first external carrier.
Relatively inexperienced exporters are generally advised to use terms that enable them to transfer the risk to their buyer at some point in the exporting county. This means that the so-called ‘D’ terms should be avoided. Under the three ‘D’ terms (Delivered at Terminal – DAT; Delivered at Place – DAP and Delivered Duty Paid – DDP) transport risks remain with the exporter until the goods have arrived at the named place in the destination country. In addition, the exporter must undertake all the delivery arrangements and meet all associated costs until this point.
SADC exporters taking advantage of the Africa Growth and Opportunities Act (AGOA), particularly where they are containerizing consignments, should be aware of the link between the merchant and carrier haulage services and trade terms. Merchant haulage refers to the port to port service offered by a shipping line. Carrier haulage extends this service to include overland haulage on both sides of the ocean voyage. Carrier haulage is therefore a multimodal service where the shipper contracts with the shipping line only and the latter then subcontracts certain legs of a transit to other carriers. Where merchant haulage is being used, the ‘sea freight only’ terms (FAS (Free Alongside Ship), FOB, CFR (Cost and Freight) and CIF) apply. However, where a container is being moved under a carrier haulage arrangement, only the multimodal terms FCA (Free Carrier), CPT (Carriage Paid to) or CIP should be selected. Under each of these terms, the seller’s risks, costs and organizational responsibilities terminate when the goods are handed over to the carrier, usually at the exporter’s premises. However, his costs may extend to include the freight costs (CPT) and both freight and cargo insurance (CIP).
Resources
ITRISA: ITRISA offers distance education, short training courses, and trade consultancy, in-house training. For more information, visit www.itrisa.co.za
International Chamber of Commerce: http://www.iccwbo.org
Foreign Trade On-Line Corp: www.foreign-trade.com
Export Digest hopes this article has been useful, especially to small and inexperienced exporters. Again, Export Digest advises exporters to pay attention to the Incoterms when negotiating or agreeing to an international sales contract.
Cos Mamhunze
Column Editor
Cos is an international trade specialist with more than 12 years’ experience promoting international trade between Africa and the US and intra-regional trade within Southern Africa. His work has involved working with small and medium enterprises (SMEs) and large firms, women-owned enterprises, importers, exporters, trade support institutions as well as government departments. Cos holds a MBA and has studied International Trade Management.
Opinions expressed in this column are not necessarily those of USAID or the Trade Hub.
Next Article: Subsequent Export Digest articles will focus specifically on the textiles and garments sectors.
The seven rules defined by Incoterms 2010 for any mode(s) of transportation are:
EXW – Ex Works (named place of delivery)
The seller makes the goods available at its premises. This term places the maximum obligation on the buyer and minimum obligations on the seller. The Ex Works term is often used when making an initial quotation for the sale of goods without any costs included. EXW means that a seller has the goods ready for collection at his premises (works, factory, warehouse, plant) on the date agreed upon. The buyer pays all transportation costs and also bears the risks for bringing the goods to their final destination. The seller doesn't load the goods on collecting vehicles and doesn't clear them for export. If the seller does load the good, he does so at buyer's risk and cost. If parties wish seller to be responsible for the loading of the goods on departure and to bear the risk and all costs of such loading, this must be made clear by adding explicit wording to this effect in the contract of sale.
FCA – Free Carrier (named place of delivery)
The seller hands over the goods, cleared for export, into the disposal of the first carrier (named by the buyer) at the named place. The seller pays for carriage to the named point of delivery, and risk passes when the goods are handed over to the first carrier.
CPT – Carriage Paid To (named place of destination)
The seller pays for carriage. Risk transfers to buyer upon handing goods over to the first carrier.
CIP – Carriage and Insurance Paid to (named place of destination)
The containerized transport/multimodal equivalent of CIF. Seller pays for carriage and insurance to the named destination point, but risk passes when the goods are handed over to the first carrier.
DAT – Delivered at Terminal (named terminal at port or place of destination)
Seller pays for carriage to the terminal, except for costs related to import clearance, and assumes all risks up to the point that the goods are unloaded at the terminal.
DAP – Delivered at Place (named place of destination)
Seller pays for carriage to the named place, except for costs related to import clearance, and assumes all risks prior to the point that the goods are ready for unloading by the buyer.
DDP – Delivered Duty Paid (named place of destination)
Seller is responsible for delivering the goods to the named place in the country of the buyer, and pays all costs in bringing the goods to the destination including import duties and taxes. This term places the maximum obligations on the seller and minimum obligations on the buyer.
The four rules defined by Incoterms 2010 for international trade where transportation is entirely conducted by water are:
FAS – Free Alongside Ship (named port of shipment)
The seller must place the goods alongside the ship at the named port. The seller must clear the goods for export. Suitable only for maritime transport but NOT for multimodal sea transport in containers (see Incoterms 2010, ICC publication 715). This term is typically used for heavy-lift or bulk cargo.
FOB – Free on Board (named port of shipment)
The seller must load the goods on board the vessel nominated by the buyer. Cost and risk are divided when the goods are actually on board of the vessel (this rule is new!). The seller must clear the goods for export. The term is applicable for maritime and inland waterway transport only but NOT for multimodal sea transport in containers (see Incoterms 2010, ICC publication 715). The buyer must instruct the seller the details of the vessel and the port where the goods are to be loaded, and there is no reference to, or provision for, the use of a carrier or forwarder. This term has been greatly misused over the last three decades ever since Incoterms 1980 explained that FCA should be used for container shipments.
CFR – Cost and Freight (named port of destination)
Seller must pay the costs and freight to bring the goods to the port of destination. However, risk is transferred to the buyer once the goods are loaded on the vessel (this rule is new!). Maritime transport only and Insurance for the goods is NOT included. This term is formerly known as CNF (C&F).
CIF – Cost, Insurance and Freight (named port of destination)
Exactly the same as CFR except that the seller must in addition procure and pay for the insurance. Maritime transport only.
Source: http://en.wikipedia.org/wiki/Incoterms
It is commercial suicide, when negotiating an international sales contract, to ignore Incoterms.
First published in 1936, the Incoterms have been regularly updated. The latest, Incoterms 2010 (8th version), was published on January 1, 2011 by the International Chamber of Commerce (ICC).
Export Digest has engaged Rose Blatch, an expert in export training, to demystify Incoterms.
Are you selecting FOB or CIF when you should be selling under FCA or CIP?
Understanding the ICC’s Incoterms® 2010 Rules is a critical step to achieving sustainable export success.
Nearly all those engaged in international trade will have come across the terms EXW (Ex Works), FOB (Free on Board) and CIF (Cost, Insurance and Freight) at some point. However, a surprising number of African importers and exporters are unaware that these are just three out of eleven terms that are currently in widespread use. FOB and CIF, in particular, are frequently selected when they are totally inappropriate.
Why is this so important?
It is important to understand that trade or commercial terms have evolved over the years to simplify the thorny issue of who organizes, pays for, and bears the risk for loss of, or damage to, goods while they are in transit.
Misunderstandings over the allocation of delivery-related tasks led the International Chamber of Commerce in Paris, France, to introduce standardized rules governing the obligations of each contractual party in the 1930s.
These rules were intended for universal use; however, although adopted by most of the world soon after they were first introduced, they have only in recent years, for example, replaced the American trade definitions in the USA. Since their introduction, the ICC’s rules, known as the Incoterms®, have undergone numerous revisions aimed at reducing misunderstandings and ensuring the relevance of the terms in a rapidly changing world.
Today, Incoterms® play a key role in sales contracts. Where a particular term is stated in a contract, the international rules automatically apply. These rules have been translated into all the world’s most commonly used languages and so are universally understood. Although each of the eleven terms has a name, it also has a three letter international symbol. Thus ‘Ex Works’ is depicted as EXW; ‘Free On Board’ as FOB; ‘Cost, Insurance and Freight’ as CIF, etc.
Although trade terms have been in use for almost as long as cargoes have been transported across oceans, and the standardized ICC Rules have applied since the 1930s, parties to sales transactions have often been embroiled in disputes because their understanding of their own obligations (and those of the other party) have been at odds with the expectations of their counterparts. In addition, often – and particularly in a Southern African context – incorrect terms have been used for export transactions. Although these errors may not have proved catastrophic at the time, had the cargoes concerned been subject to accident or theft while in transit, the outcomes could have been very different.
Duties of buyer/seller according to Incoterms 2010 (http://en.wikipedia.org/wiki/Incoterms)
| Incoterm | Loading on truck (carrier) | Export-Customs declaration | Carriage to port of export | Unloading of truck in port of export | Loading charges in port of export | Carriage to port of import | Unloading charges in port of import | Loading on truck in port of import | Carriage to place of destination | Insurance | Import customs clearance | Import taxes |
| EXW | Buyer | Buyer | Buyer | Buyer | Buyer | Buyer | Buyer | Buyer | Buyer | Buyer | Buyer | Buyer |
| FCA | Seller | Seller | Seller | Buyer | Buyer | Buyer | Buyer | Buyer | Buyer | Buyer | Buyer | Buyer |
| FAS | Seller | Seller | Seller | Seller | Buyer | Buyer | Buyer | Buyer | Buyer | Buyer | Buyer | Buyer |
| FOB | Seller | Seller | Seller | Seller | Seller | Buyer | Buyer | Buyer | Buyer | Buyer | Buyer | Buyer |
| CFR | Seller | Seller | Seller | Seller | Seller | Seller | Buyer | Buyer | Buyer | Buyer | Buyer | Buyer |
| CIF | Seller | Seller | Seller | Seller | Seller | Seller | Buyer | Buyer | Buyer | Seller | Buyer | Buyer |
| DAT | Seller | Seller | Seller | Seller | Seller | Seller | Seller | Buyer | Buyer | Buyer | Buyer | Buyer |
| CPT | Seller | Seller | Seller | Seller | Seller | Seller | Seller | Seller | Seller | Buyer | Buyer | Buyer |
| DAP | Seller | Seller | Seller | Seller | Seller | Seller | Seller | Seller | Seller | Seller | Buyer | Buyer |
| CIP | Seller | Seller | Seller | Seller | Seller | Seller | Seller | Seller | Seller | Seller | Buyer | Buyer |
| DDP | Seller | Seller | Seller | Seller | Seller | Seller | Seller | Seller | Seller | Seller | Seller | Seller |
The most frequent error is the inclusion in a contract, where delivery is to take place by road or rail, of a term intended only for goods moving along inland waterways or across oceans. The latest Revision (2010) of the Incoterms® now specifically groups the eleven terms into two categories: those terms that are used exclusively for water transport; and those that can be used for any mode of transport, including multimodal transport. The terms intended only for goods moving by sea and/inland waterway make a clear reference to the goods being ‘loaded on board the vessel’ and are always qualified by the name of a port. Hence the term appears, for example, as FOB Walvis Bay, or CIF Houston.
Under a sea freight term, the critical point at which the risk inherent in delivery passes from the seller to a buyer will always be either a port quayside, or the deck of a vessel berthed in the port. If a sea freight term is used and the goods never enter a port or get loaded on a vessel, the risk remains perpetually with the seller. Therefore, if a road hauler is involved in an accident, or a railway wagon is derailed resulting in damage to or loss of the cargo, the seller will bear the risk. This can be contrary to the expectations of a seller who believes his risk is over once the goods are loaded on the truck/wagon.
Some years ago, a Zambian exporter of copper wire to Malawi faced just such a problem. He dispatched the cargo CIF Blantyre, anticipating that he would pay the transport cost to the Malawian commercial center but would be free of risk once the road hauler had collected the consignment from his factory warehouse. Unfortunately, shortly after crossing the Zambian/Malawian border, the vehicle was involved in an accident and its load strewn across the road. Although some of the cargo was salvaged, the buyer eventually received only around 35% of his order. When he refused to pay the invoice value, the Zambian exporter threatened litigation but subsequently withdrew his case on discovering that he still carried the risk in the venture. He had no legal recourse as the cargo had not been loaded on board a vessel.
In the circumstances described above, the correct term to have used would have been CIP (Carriage and Insurance Paid to) Blantyre. Under CIP, the exporting company would have paid for the carriage, but the risk in delivery would have passed to the buyer at the time that the consignment was handed over to the first external carrier.
Relatively inexperienced exporters are generally advised to use terms that enable them to transfer the risk to their buyer at some point in the exporting county. This means that the so-called ‘D’ terms should be avoided. Under the three ‘D’ terms (Delivered at Terminal – DAT; Delivered at Place – DAP and Delivered Duty Paid – DDP) transport risks remain with the exporter until the goods have arrived at the named place in the destination country. In addition, the exporter must undertake all the delivery arrangements and meet all associated costs until this point.
SADC exporters taking advantage of the Africa Growth and Opportunities Act (AGOA), particularly where they are containerizing consignments, should be aware of the link between the merchant and carrier haulage services and trade terms. Merchant haulage refers to the port to port service offered by a shipping line. Carrier haulage extends this service to include overland haulage on both sides of the ocean voyage. Carrier haulage is therefore a multimodal service where the shipper contracts with the shipping line only and the latter then subcontracts certain legs of a transit to other carriers. Where merchant haulage is being used, the ‘sea freight only’ terms (FAS (Free Alongside Ship), FOB, CFR (Cost and Freight) and CIF) apply. However, where a container is being moved under a carrier haulage arrangement, only the multimodal terms FCA (Free Carrier), CPT (Carriage Paid to) or CIP should be selected. Under each of these terms, the seller’s risks, costs and organizational responsibilities terminate when the goods are handed over to the carrier, usually at the exporter’s premises. However, his costs may extend to include the freight costs (CPT) and both freight and cargo insurance (CIP).
Resources
ITRISA: ITRISA offers distance education, short training courses, and trade consultancy, in-house training. For more information, visit www.itrisa.co.za
International Chamber of Commerce: http://www.iccwbo.org
Foreign Trade On-Line Corp: www.foreign-trade.com
Export Digest hopes this article has been useful, especially to small and inexperienced exporters. Again, Export Digest advises exporters to pay attention to the Incoterms when negotiating or agreeing to an international sales contract.
Cos Mamhunze
Column Editor
Cos is an international trade specialist with more than 12 years’ experience promoting international trade between Africa and the US and intra-regional trade within Southern Africa. His work has involved working with small and medium enterprises (SMEs) and large firms, women-owned enterprises, importers, exporters, trade support institutions as well as government departments. Cos holds a MBA and has studied International Trade Management.
Opinions expressed in this column are not necessarily those of USAID or the Trade Hub.
Next Article: Subsequent Export Digest articles will focus specifically on the textiles and garments sectors.
The seven rules defined by Incoterms 2010 for any mode(s) of transportation are:
EXW – Ex Works (named place of delivery)
The seller makes the goods available at its premises. This term places the maximum obligation on the buyer and minimum obligations on the seller. The Ex Works term is often used when making an initial quotation for the sale of goods without any costs included. EXW means that a seller has the goods ready for collection at his premises (works, factory, warehouse, plant) on the date agreed upon. The buyer pays all transportation costs and also bears the risks for bringing the goods to their final destination. The seller doesn't load the goods on collecting vehicles and doesn't clear them for export. If the seller does load the good, he does so at buyer's risk and cost. If parties wish seller to be responsible for the loading of the goods on departure and to bear the risk and all costs of such loading, this must be made clear by adding explicit wording to this effect in the contract of sale.
FCA – Free Carrier (named place of delivery)
The seller hands over the goods, cleared for export, into the disposal of the first carrier (named by the buyer) at the named place. The seller pays for carriage to the named point of delivery, and risk passes when the goods are handed over to the first carrier.
CPT – Carriage Paid To (named place of destination)
The seller pays for carriage. Risk transfers to buyer upon handing goods over to the first carrier.
CIP – Carriage and Insurance Paid to (named place of destination)
The containerized transport/multimodal equivalent of CIF. Seller pays for carriage and insurance to the named destination point, but risk passes when the goods are handed over to the first carrier.
DAT – Delivered at Terminal (named terminal at port or place of destination)
Seller pays for carriage to the terminal, except for costs related to import clearance, and assumes all risks up to the point that the goods are unloaded at the terminal.
DAP – Delivered at Place (named place of destination)
Seller pays for carriage to the named place, except for costs related to import clearance, and assumes all risks prior to the point that the goods are ready for unloading by the buyer.
DDP – Delivered Duty Paid (named place of destination)
Seller is responsible for delivering the goods to the named place in the country of the buyer, and pays all costs in bringing the goods to the destination including import duties and taxes. This term places the maximum obligations on the seller and minimum obligations on the buyer.
The four rules defined by Incoterms 2010 for international trade where transportation is entirely conducted by water are:
FAS – Free Alongside Ship (named port of shipment)
The seller must place the goods alongside the ship at the named port. The seller must clear the goods for export. Suitable only for maritime transport but NOT for multimodal sea transport in containers (see Incoterms 2010, ICC publication 715). This term is typically used for heavy-lift or bulk cargo.
FOB – Free on Board (named port of shipment)
The seller must load the goods on board the vessel nominated by the buyer. Cost and risk are divided when the goods are actually on board of the vessel (this rule is new!). The seller must clear the goods for export. The term is applicable for maritime and inland waterway transport only but NOT for multimodal sea transport in containers (see Incoterms 2010, ICC publication 715). The buyer must instruct the seller the details of the vessel and the port where the goods are to be loaded, and there is no reference to, or provision for, the use of a carrier or forwarder. This term has been greatly misused over the last three decades ever since Incoterms 1980 explained that FCA should be used for container shipments.
CFR – Cost and Freight (named port of destination)
Seller must pay the costs and freight to bring the goods to the port of destination. However, risk is transferred to the buyer once the goods are loaded on the vessel (this rule is new!). Maritime transport only and Insurance for the goods is NOT included. This term is formerly known as CNF (C&F).
CIF – Cost, Insurance and Freight (named port of destination)
Exactly the same as CFR except that the seller must in addition procure and pay for the insurance. Maritime transport only.
Source: http://en.wikipedia.org/wiki/Incoterms
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