What are Incoterms? Why do they matter to the international shipping industry?
In international shipping, even the slightest misunderstanding can lead to costly delays, disputes, and even late deliveries. This is where Incoterms come in handy. Incoterms are a standardized set of business terms that define the responsibilities of buyers and sellers in global transactions.
Whether you’re an e-commerce seller shipping products across borders or a customer service representative handling international shipping issues, understanding Incoterms and their importance to the shipping industry is crucial. These terms influence everything from freight payments to customs clearance, directly impacting shipping agreements, logistics management, and even cargo traceability.
Incoterms are internationally recognized rules published by the International Chamber of Commerce (ICC) that define the responsibilities of buyers and sellers in global trade. First introduced in 1936, Incoterms has been regularly updated, with the latest version being the 2020 edition of Incoterms (Incoterms 2020). These trade terms are widely used in international contracts to clarify responsibilities for shipping, insurance, customs clearance, and other logistics-related tasks.
The International Chamber of Commerce (ICC) developed the Incoterms (International Commercial Terms) to establish a common language for global trade and reduce confusion and legal disputes. By clearly defining the transfer of risks and costs from seller to buyer, Incoterms help standardize shipping regulations and practices. For small businesses and online sellers, using the right Incoterms can streamline cross-border shipping processes and improve communication with logistics partners.
For example, if you are shipping from China to the United States and want to know when your responsibility ends and the buyer’s begins, Incoterms can provide clarity. This is especially important when working with international couriers like FedEx or DHL, where timeliness and documentation are crucial.
The Importance of Incoterms in Cross-Border Trade
In cross-border trade, Incoterms play a key role in determining how responsibilities are shared between exporters and importers. Incoterms lay the foundation for international contracts, influencing not only shipping agreements but also import and export guidelines and compliance with shipping regulations.
Here are some reasons why Incoterms are important:
Contract Clarity: Incoterms reduce ambiguity in international contracts by clarifying logistics responsibilities.
Customs and Compliance: They facilitate compliance with local customs clearance procedures and import regulations.
Logistics Management: Knowing who will pay for freight, insurance, and duties facilitates effective planning and budgeting.
Trade Finance: Financial institutions often require the use of specific Incoterms in trade finance documents, such as letters of credit.
For e-commerce sellers, using the wrong Incoterms can lead to unexpected costs or shipping delays. For example, if the international trade terms (Incoterms) you choose stipulate that you are responsible for customs clearance in the buyer’s country, and you’re unfamiliar with local regulations, you may experience delays. If you’re trying to resolve issues such as long delivery times, inconsistent Incoterms can be a contributing factor.
Common Incoterms Explained
Of the 11 Incoterms defined in the 2020 update, some are more commonly used in everyday shipping. Understanding these terms is crucial for choosing the most appropriate shipping term and avoiding any confusion.
Comparison of the 2020 and 2010 Incoterms
The 2020 revision introduces updates that align with current global trade practices. Key differences include replacing DAT (Delivered at Place of Terminal) with DPU (Delivered at Place of Unloaded) and clarifying insurance obligations under CIF and CIP terms. These changes affect how risks and liabilities are handled in transport documents.
- What does IMO mean?
- How did the Baltimore Bridge Collapse?
- Sailors Head Home Months After Baltimore Bridge Crash
- What is Formal Safety Assessment?
- What is the IMSBC Code?
Common International Trade Terms and Their Meanings
FOB (Free on Board): The seller delivers the goods onto the vessel at the port of shipment; risk transfers to the buyer at the port of shipment. This is a common term used in ocean freight.
CIF (Cost, Insurance and Freight): The seller pays the transportation and insurance costs to the port of destination, but risk transfers after the goods are loaded on board.
EXW (Ex Works): The buyer assumes responsibility once the goods arrive at the seller’s premises. The buyer is responsible for all shipping and customs duties.
DDP (Delivered Duty Paid): The seller bears all costs and risks, including customs duties, until the goods are delivered to the buyer.
Each Incoterm sets out specific obligations for both the buyer and the seller. For example, under Delivered Duty Paid (DDP), the seller must clear customs in the buyer’s country, a process that can be complex if the destination has strict import regulations. If you’re tracking a shipment and wondering why it hasn’t arrived, the Incoterm used may explain the delay.
How do Incoterms govern transport contracts?
Incoterms are more than just shipping terms; they are a crucial component of the transport contract between buyer and seller. They determine which parts of the transport process are borne by whom, when risk transfers from seller to buyer, and who is responsible for managing key logistical tasks.
These responsibilities include:
Cost Allocation: Freight, insurance, duties, and loading and unloading charges are allocated according to the Incoterms used.
Risk Transfer: Each term specifies when the risk of loss or damage to the goods transfers from the seller to the buyer.
Shipping Documents: Incoterms specify who is responsible for preparing and submitting shipping documents, such as bills of lading or commercial invoices.
For example, in a CIF (cost, insurance, and freight) contract, the seller must provide insurance and shipping documents to the port of destination, while the buyer is responsible for import customs clearance. If you encounter problems such as customs delays, understanding the Incoterms used can help determine who should intervene to resolve the issue.
In supply chain logistics, using the correct Incoterms can help streamline processes and avoid misunderstandings. It also ensures that all parties agree on their respective responsibilities, which is crucial when dealing with international couriers and customs authorities.
How Do Incoterms Affect Shipping Costs and Responsibilities?
Incoterms directly affect the allocation of shipping costs and the responsibilities for specific expenses during transportation. Understanding these responsibilities will help you avoid unexpected expenses and delays, especially in international shipping, where shipping costs, duties, and insurance can significantly impact your profits.
Each Incoterm clearly specifies who pays:
Freight: Depending on the terms, either the seller or the buyer bears the costs of transporting the goods to their destination.
Insurance: Certain Incoterms, such as CIF and CIP, require the seller to provide minimum insurance during transportation.
Import Duties and Taxes: Terms like DDP assign responsibility for import duties to the seller, while EXW assigns responsibility for import duties to the buyer. These cost allocations are closely tied to import and export guidelines, which vary by country. For example, if you’re exporting to the EU, using “DDP” means you’re responsible for complying with EU VAT and customs clearance procedures. Choosing the wrong Incoterm can lead to customs delays, unexpected fees, or even shipment rejections.
For e-commerce sellers shipping internationally, choosing the right Incoterm helps maintain transparency with buyers and streamlines logistics management. It also provides better cost predictability when negotiating international shipping agreements.
Incoterms and Shipment Tracking Clarity
Incoterms also influence how and when shipment tracking updates are issued, especially in cross-border trade. Because these terms precisely define the point at which responsibility and risk transfer from the seller to the buyer, they directly influence how tracking systems interpret carrier deliveries and delivery milestones.
The impact of Incoterms on tracking clarity is as follows:
Risk Transfer: If the Incoterm specifies that risk transfers at the port of origin (e.g., FOB), the buyer assumes responsibility once the goods are loaded on board. Subsequent tracking updates may be the responsibility of the buyer’s logistics provider. Delivery Point (DAP): Terms such as FCA or DAP specify the location where the shipment is delivered to the carrier. This point typically marks the immediate start of tracking through the courier system.
Customs and Delays: If customs clearance is the buyer’s responsibility, tracking updates may be temporarily suspended until the buyer completes the required documentation.
For logistics companies and tracking platforms, understanding the Incoterms used can help better coordinate the various stages of shipping. If you’re wondering why a package is stuck in transit or “awaiting customs clearance,” Incoterms can clarify who should take action to resolve the delay.
The Role of Incoterms in International Shipping Policy
Incoterms are often incorporated into national and international shipping regulations, making them a reference in legal and commercial frameworks. Governments and customs authorities use these trade terms to determine responsibilities, compliance requirements, and tax obligations in global trade transactions.
The impact of Incoterms on international shipping policy is as follows:
Regulatory compliance: Customs authorities rely on Incoterms to determine who is responsible for duties, VAT, and documentation.
Dispute resolution: In shipping disputes, courts and arbitration tribunals often refer to agreed-upon Incoterms to assess liability and damages.
Insurance claims: Insurance companies use Incoterms to assess who bears the risk of loss or damage, which can impact the outcome of a claim.
For companies engaged in cross-border trade, adhering to Incoterms helps comply with shipping regulations and avoid legal disputes. If you manage international freight and face a claim or compliance issue, reviewing the agreed-upon Incoterms is often the first step to resolving the issue. Choosing the Right Incoterm for Your Shipment
Choosing the right Incoterm depends on a variety of factors, including your shipping strategy, the regulations of the destination country, and your logistics capabilities. The wrong choice can lead to cost overruns, customs issues, or failed deliveries, especially for small businesses and online sellers expanding into new markets.
When choosing an Incoterm, consider the following key factors:
Buyer-Seller Relationship: Consider the degree of control each party has over the shipping process. Sellers with a strong logistics network may prefer Delivered Duty Paid (DDP), while buyers with local expertise may choose Delivered Exported (EXW).
Destination Country Regulations: Some countries have strict import procedures. Choosing an Incoterm that delegates customs clearance to an agency familiar with local laws can reduce delays.
Mode of Transport: Terms like FOB and CIF apply only to ocean freight, while terms like CIP and DAP apply to all modes of transport.
Cost and Risk Assumed: If you want to reduce the risk of customs duties or insurance claims, choose terms that transfer responsibility early in the shipping process. For e-commerce sellers, DAP or DDP terms are often preferred to provide a better customer experience by including delivery and customs duties.
However, these terms require a thorough understanding of the buyer’s local customs procedures. If you’re a buyer, understanding the Incoterms used will help you accurately track your shipments and prepare for any import liabilities.
Tips for Importers, Exporters, and E-commerce Businesses
Making Incoterms clear in trade agreements is a key step in streamlining global shipping processes. For importers, exporters, and small e-commerce businesses, understanding how each Incoterm defines responsibilities can help reduce misunderstandings, expedite customs clearance, and avoid delivery issues. Managing transportation contracts and logistics operations becomes much easier when Incoterms are well-documented.
Here are some practical tips for effectively applying Incoterms:
Clearly define Incoterms in all trade documents: Clearly document the agreed-upon terms and location (e.g., Delivered Duty Paid (DDP) at New York Port) in sales contracts, invoices, and shipping instructions. Discuss and confirm before the sale: Agree on the Incoterms with the buyer or seller at the outset of negotiations to avoid disputes during customs clearance.
Train your logistics or support team: Ensure your staff fully understands the import and export guidelines and responsibilities under each Incoterm to efficiently handle shipping.
Proactive communication and accurate documentation can reduce the risk of misunderstandings that can lead to shipping delays or additional costs, especially in supply chain logistics involving multiple shipping regulations and countries.
Common Mistakes and Misunderstandings
Misusing or misunderstanding Incoterms can easily lead to shipping contract conflicts, insurance issues, or customs disputes, especially for small businesses entering the international market. Understanding the most common mistakes can help you avoid these errors and maintain better shipping agreements.
Using Incoterms for Domestic Shipping: Incoterms were designed for international trade. Applying them to domestic shipping often leads to confusion and a lack of legal clarity.
Assuming Costs Are Always Included: Some sellers mistakenly believe that Incoterms such as CIP or CIF automatically provide full insurance. However, these terms only require minimum insurance unless otherwise agreed upon.
Ignoring Incoterms Updates: Using outdated terms, such as the 2010 version of DAT instead of DPU (included in the 2020 Incoterms), can lead to documentation errors and delays in freight processing.
Avoiding these errors can improve your shipping efficiency and reduce the risk of non-compliance with delivery responsibilities, especially in cross-border trade involving multiple parties in the supply chain.
Incoterms and Customs Clearance Delays
Incorrect or unclear use of Incoterms often leads to customs clearance issues in international shipments. Because these commercial terms define who is responsible for import duties, documentation, and customs compliance, using the wrong term can result in delivery delays or fines.
How Do Incoterms Affect Customs Procedures?
Confusion of Responsibilities: If the buyer and seller have different expectations regarding who should process customs documents, shipments may be detained at the border.
Risk of Document Loss: Incorrectly designating the provider of a commercial invoice or certificate of origin can lead to customs inspection or detention.
Failure to Comply with Country-Specific Regulations: Some Incoterms place the responsibility on you to understand and comply with the import regulations of the destination country. Skipping even one step can lead to customs clearance delays.
By carefully selecting Incoterms and clarifying the chain of custody for shipping documents, you can help facilitate international deliveries and reduce delays with customs authorities. Frequently Asked Questions about Incoterms for Ocean Freight
Incoterms often raise practical questions for shippers, buyers, and international support teams who manage logistics and commercial terms. This section will answer some common questions to help you make more informed shipping decisions and avoid issues that affect costs, documentation, and risk allocation.
Can Incoterms be customized between parties?
Yes, although Incoterms are standardized, parties can agree to modify or clarify their scope, provided these modifications are clearly stated in the contract. It is important to clearly mention these changes in the ocean freight agreement to avoid disputes during transportation or customs clearance. Always refer to the exact version of the Incoterms being used, such as the 2020 Incoterms.
Is the term “FOB” only applicable to ocean freight?
Yes, the term “FOB” (Free on Board) only applies to ocean freight. If your goods are transported by air or land, consider using a term such as “FCA” (Free Carrier). Using “FOB” in international shipping contracts can create legal ambiguity or confusion.
How do Incoterms affect tracking notifications?
Incoterms influence the transfer of title from seller to buyer, thus affecting when and how tracking updates are displayed. Using terms like FCA or FOB, the buyer may only begin receiving tracking updates after the goods have been delivered to the designated carrier. This can create tracking gaps if liability is unclear.
Does the choice of Incoterms affect the trade finance process?
Yes, financial institutions often require the use of specific Incoterms in trade finance documents, such as letters of credit. Some Incoterms also specify who must submit important documents, such as insurance policies or bills of lading. Using the wrong term can delay approval or payment for trade finance transactions.
Can Incoterms help resolve maritime disputes?
Of course. If problems or losses occur during transportation, the agreed-upon Incoterms will determine who is responsible at the time of the incident. This makes it easier for courts, insurance companies, and arbitration institutions to determine liability, especially in cross-border trade. Strict application of Incoterms also helps strengthen accountability in the event of a dispute.
