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Why Understanding Incoterms Is Critical to International Supply Chain Management

Last modified: February 23, 2017

International Commerce Terms, or Incoterms, are a set of international trade rules for common trade terms. These terms govern seller and buyer responsibilities in moving product between countries, and they are redefined every 10 years by the International Chamber of Commerce (ICC). More importantly, many online sources reference 13 Incoterms in use, but the ICC’s revision of Incoterms in 2010 reduced the number of Incoterms to 11. So, you could be engaged in trade and using incorrect Incoterms without even realizing it. Thus, you need to know how understanding the correct Incoterms prevents disruptions within and enhances global supply chain management.

Incoterms Are Classified Into Two Groups

The first key to understanding Incoterms is understanding how they are categorically defined. The first seven Incoterms refer to any mode or modes of transportation. Meanwhile, the final four Incoterms govern common practices while transporting goods by sea or inland waterways.

Not understanding how the Incoterm operates can lead to severe miscommunications and unnecessary costs or delays in shipping. More importantly, some Incoterms, such as “Free Carrier” can have different connotations. In other words, they sound differently than they are.

For example, “Free Carrier” sounds like it implies “free shipping.” Yet, it refers to the seller delivering the goods to the carrier or appropriate party on the seller’s premises. Meanwhile, the buyer may have the obligation to pay for the carrier services if specified in the contract.

What Do the Current Incoterms Mean?

  • EXW – Ex Works. This means the seller fulfills its obligation when it places goods on the seller’s premises, ready to be picked up by the buyer.
  • FCA – Free Carrier. This term means the seller delivers goods to the carrier or person identified by the buyer on the seller’s premises.
  • CPT – Carriage Paid To is a term that describes the scenario when the seller delivers goods to the carrier or person identified at another agreed upon location. More importantly, this term indicates the seller must pay for the costs to transport goods to such agreed upon place.
  • CIP – Carriage and Insurance Paid To. This basically is an expansion of CPT, as the seller agrees to pay for insurance to protect from buyer’s risk of loss or damage to goods during transit to the agreed upon place. However, the seller must only obtain minimum coverage, so buyers may want to purchase additional protection.
  • DAT – Delivered At Terminal. This term obligates the seller to deliver goods to the buyer at an identified terminal, which may include a quay, warehousing, shipping yard or a rail or air cargo terminal, and unload such goods for the buyer.
  • DAP – DeliverUnderstanding Incotermsed at Place is an expansion of DAT by requiring the seller to deliver and unload goods to the disposal of the buyer at a named destination.
  • DDP – Delivered Duty Paid. This simply means that the seller must transport goods to a destination and have them cleared for import, including the payment of duties or tariffs for importing or exporting products across borders.
  • FAS – Free Alongside Ship. This term means the seller delivers when goods are placed alongside a vessel at a defined port, transferring risk and responsibility to the buyer upon placement alongside the vessel.
  • FOB – Free On Board. This term requires the seller to deliver products to a vessel, ensure they are boarded and procures goods so delivered.
  • CFR – Cost and Freight is like FOB, but the seller fulfills his obligation when goods are delivered and boarded upon a vessel, and the seller must pay for costs and freight to be delivered at the port of destination depending on the remainder of terms within the contract.
  • CIF Cost – Insurance and Freight expands CFR to require the seller to obtain insurance to cover the goods, but insurance is only a minimum cover. If the buyer wants to purchase additional coverage, he or she must pay for it.

What Does It All Mean?

Failure to use the current 11 Incoterms correctly may reveal illegitimate, unethical business/trade practices. More importantly, not using or understanding them could leave the buyer or seller with more financial and customs’ responsibility than the other party. Furthermore, goods could be seized at the time of import for failure to pay duties if parties do not understand who bears that obligation. Primarily, Incoterms help the global supply chain keep moving by preventing bottlenecks from confusion over who is responsible for the risk and transport of purchased goods during international trade.

Any company that relies on shipping goods in the global marketplace needs to have a strong understanding of Incoterms, or employ the services of a full-service supply chain solutions provider who can handle all aspects of global trade compliance.  To learn more about the trade compliance guidance Flash Global offers as part of our end-to-end service supply chain solutions, contact us today.

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