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What are incoterms and why should you care about them?

Have you ever tried to talk to a supplier about shipping, only for them to throw a bunch of strange acronyms (like DDP and CIF) at you? You're not alone. These acronyms, known as incoterms, significantly impact your shipping process – but they're notoriously confusing to buyers.

However, incoterms exist to reduce confusion between buyers and suppliers, not cause it. An incoterm provides one universal definition for a series of tasks, responsibilities, and decisions; when you and your supplier both understand the terms, your shipping discussions will be more efficient. By familiarizing yourself with the details of each incoterm, you can choose the one that makes the most sense for your next order.

First, all incoterms define:

  • Cost: who pays for each part of the delivery?
  • Responsibility: who handles the operations for each part of the delivery?
  • Risk: when does risk of cargo loss or damage transfer from the supplier to the buyer?
  • Instructions: what information do forwarders, brokers, or other parties involved in the shipment need to know?

We can also group incoterms into three buckets:

  • E and F type: the supplier bears little cost and responsibility. Includes Ex Works (EXW), Free Carrier (FCA), Free Alongside Ship (FAS), Free Onboard (FOB)
  • C type: the supplier bears the cost and risks until the order is delivered at the destination port. Includes Cost and Freight (CFR), Cost Insurance and Freight (CIF), Carriage and Insurance Paid To (CIP), and Carriage Paid To (CPT)
  • D type: the supplier bears maximum responsibility for cost and risks. Includes Delivered at Terminal (DAT), Delivered at Place (DAP), and Delivery Duty Paid (DDP)

As you move from E to D types, the buyer's risk, knowledge required, and time commitment decreases (sounds good, right?). However, the buyer's level of control and visibility into costs also decreases (maybe not so good).

How should you decide which is right for you? The biggest factor is experience level. More experienced buyers generally want more control over the shipping process and associated costs, and they're comfortable taking on more risk and responsibility to get it. Less experienced buyers generally benefit from offloading some responsibility to their suppliers, even if it means giving up some control and price visibility. This is why generally recommends EXW for experienced buyers and FOB for new buyers; if you use logistics, you must use one of these terms.

The four most common incoterms are:

Ex Works (EXW)

  • Summary: supplier has minimal obligation; buyer assumes all costs, responsibility, and risk upon picking up goods from the supplier until final delivery
  • Pros: buyer has maximum control and visibility into costs and operations; product price is often lower than FOB product price
  • Cons: nearly all responsibility is on the buyer – the supplier is not even obligated to load the goods onto the truck. Also, navigating customs clearance in a foreign country can be difficult and expensive; the additional hassle and risk may not be worth the money saved on the product price
  • Recommended for: experienced buyers who have solid relationships with their suppliers

Free on Board (FOB)

  • Summary: supplier assumes all costs, responsibilities, and risks from the time the goods leave the factory until they pass the ship's rail at the origin port. Buyer assumes all costs, responsibilities, and risks after that point
  • Pros: this is best option for new buyers because the supplier handles much of the responsibility at origin, but the buyer still has some control over total shipping costs
  • Cons: FOB product price is usually higher than EXW product price because suppliers add markup to recoup their shipping expenses
  • Recommended for: new buyers or any buyer working with a particular supplier for the first time

Cost, Insurance, and Freight (CIF)

  • Summary: supplier assumes the costs and responsibilities to get the goods to the destination port, including insurance; however, the risk is transferred to the buyer when the goods are loaded on the ship at the origin port
  • Pros: requires minimal commitment from the buyer – the buyer doesn't need to coordinate with a freight forwarder, negotiate freight rates, deal with customs brokers, etc.
  • Cons: buyers give up control over things they have a vested interest in controlling, such as insurance coverage and Importer Security Filing (ISF). Buyers will also likely pay inflated destination handling charges, as they're working with suppliers' freight forwarders instead of their own
  • Recommended for: generally doesn't recommend CIF because of buyers' low amount of control and high risk of hidden costs

Delivered Duty Paid (DDP)

  • Summary: supplier assumes all cost, responsibility, and risk until goods are delivered to the buyer. This is the only incoterm in which the supplier is responsible for import clearance and taxes and duties; the buyer only pays for the cost of the goods themselves
  • Pros: similar to CIF – it requires minimal buyer involvement
  • Cons: similar to CIF – it gives too much control to supplier and buyers will likely pay inflated costs
  • Recommended for: for similar reasons to CIF, we don't recommend DDP for ocean shipping. However, it is more common and makes more sense for air express or parcel shipping

While these are the four most common and important incoterms to know, reference the graphic below to learn about other types you may encounter while importing goods.

Learn more about Freight

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