Updated: Dec 29, 2019
From 1 January 2020, the revised set of eleven Incoterms® will apply and businesses trading cross borders will be able to incorporate them into their sales contracts.
Here we look at what they are, why they matter, how they have changed, and explain how they if applied correctly, can expedite your cross-border shipments and enhance supply chain agility.
With great opportunity comes great responsibility
Global trade has seen unprecedented growth over the last decade, providing extraordinary opportunities for companies to expand reach to markets around the world and sell more products to a broader customer base. Today, businesses sell more goods into more countries, in larger quantities, in greater variety, and at a faster pace.
However, moving goods internationally is no easy task and requires a carefully coordinated strategy from planning to execution and the efficient coordination of many actors across the global supply chain. These partners are required to operate in sync and with each other to avoid costly supply chain delays.
Clear instructions of who must do what, where, and by when are, therefore, paramount. Such clarity can only be obtained where the two first parties to the initial sales contract, the buyer and the seller, can stick to agreed principles based on leading business-to-business practices and fix these in their contracts.
Successful principles in global trade
So, what are these fundamental “agreed principles of B2B” that set international businesses up for success in global trade? We would argue that the important ones are:
Obligations: What are my obligations as a buyer or a seller? Who arranges for transportation, carriage, insurance of the goods, who obtains the needed documentation, like import or export license?
Risk: When something goes wrong, who is responsible for providing a remedy (“sorting it”)? More formally speaking, at what point in the international transactions does the risk transfer from the seller to the buyer?
Costs: Which party is responsible for which costs, like transport, packaging, loading or unloading, and security-related costs, for example, the costs associated with a container inspection? Who pays the customs duty?
Enter the powerful Incoterms® 2020
The ICC Incoterms® 2020 rules address exactly these fundamental principles and, in this way, facilitate the conduct of global trade. Businesses that refer to Incoterms® 2020 as part of their contracts refer to rules which underpin the three principles mentioned above: the obligations, risks, and costs that sellers and buyers owe to each other under that contract.
More specifically, they indicate at what port, place or point the goods are to be delivered, where the risks are to be transferred, and they also detail who must arrange or provide carriage, insurance, trade documents, and import or export clearance. Best of all, they do it through the use of simple, commonly-used three-letter abbreviations.
But I am jumping ahead of myself….
Incoterms® 2020 – streamlining international terms of trade for almost a century
Incoterms® 2020 look modern but are not new. Already in the last century, globally trading businesses realized that the interpretation of commercial trade terms varied from country to country, causing delays, misunderstanding, and costly lawsuits.
It was the International Chamber of Commerce (ICC), which saw the need for a standard set of trade terms for importers and exporters everywhere. The first set of Incoterms® rules was published by ICC in 1936. Since then, ICC has periodically revised the rules to reflect changes in the international trade system up to the current version.
It’s not what you know; it’s what you don’t know
Over the last decades, certain myths and misperceptions have impacted the effective use of Incoterms® in cross-border transactions and their movement of goods. Let’s bust some popular myths:
Myth 1: Incoterms® 2020 transfer ownership or title of the goods sold
No, they do not deal with the ownership and do not transfer the title of goods sold, this is a matter for the actual contract of sale.
Myth 2: Incoterms® 2020 can replace a contract of sale
Of course not! Incoterms® 2020 are not in themselves a contract of sale and cannot function as a replacement for one. This is obvious when you understand that they omit many aspects essential to sales contracts such as the specifications, quantity or quality of the goods sold, the time, place, method, or currency of payment of the price.
Myth 3: From the Incoterms® 2020 I can determine if contract breaches have been committed
The Incoterms® 2020 does not comment on a potential violation of contract, for example, due to a delivery delay and does not mention any consequences or remedies which can be sought after.
Myth 4: The Incoterms® 2020 in my sales contract automatically applies to all other contracts I sign to fulfill it, such as letters of credit, carriage, or insurance contracts.
No, they do not form part of any other contract other than the sales contract and even then, they have limitations and can only sensibly operate within a properly drafted contract of sale.
Of course, both buyer and seller would want the auxiliary contracts – for example, with the carrier or the banks – to be aligned as much as possible to ensure an efficient movement of goods and rapid payment. So, while Incoterms® 2020 may not form part of other contracts, they surely have an impact on them.
Finally, we should clarify Incoterms® 2020 do not deal with the effect of sanctions, the imposition of tariffs, import or export prohibitions or restrictions, force majeure, or any intellectual property rights issues.
Not entirely, however, the reference to the 2001 movie may be a useful analogy to remember that the ICC Incoterms® 2020 Rules are abbreviated by eleven regularly used standard three-letter trading terms (starting with one of the four letters E, F, C or D). Each term reflects a different b-2-b practice for the transport of goods in international trade.
Incoterms® 2020 methodology
So, what are they like? Well, as in 2010, the eleven trade terms continue to be organized in two ways: first, according to the means of transport used and second, by the point of delivery of the goods. Let’s talk some more movies:
The Magnificent Seven
The first class of Incoterms® 2020 is known as the “Multimodal” group, there are seven, and they can be, applied to any mode of transport, including road, rail, sea, and air. They are:
EXW (= Ex Works)
FCA (= Free Carrier)
CPT (= Carriage Paid To)
CIP (= Carriage and Insurance Paid To)
DAP (= Delivered at Place)
DPU (=Delivered at Place Unloaded)
DDP (= Delivered Duty Paid)
The four remaining terms belong to the second class of “maritime” Incoterms® 2020, they relate to sea and inland waterway transport only, or simpler, ports. They are
FAS (= Free Alongside Ship)
FOB (= Free on Board)
CFR (= Cost and Freight)
CIF (= Cost, Insurance, and Freight)
There is also an internal order within each Incoterm rule. These have been organized by ten “topics” (or articles” in ICC lingo), broadly by order of importance, with each rule following the same sequence. They provide an easily identifiable and holistic description of the obligations which befall on buyer and seller.
First, there are general obligations about goods & payments, followed by “delivery/taking delivery” and “transfer of risks.” The relationship with third parties is governed by the rules on “carriage” and “Insurance.”
Next, there is a section on “delivery/transport document” and “export/import clearance,” which is followed by the obligations for “checking/packaging/ marking”. Costs and the question of who pays what are then described, before finishing with the requirements to notify buyer or seller at specific points during the shipment.
The devil is in the details: What’s different from the 2010 version?
You may be forgiven if you think that not much has changed from the 2010 version. Some observers, who may have hoped for a radical shake-up – such as the elimination of EXW or the addition or a new mode of transport covering space travel – were disappointed.
They may argue that the simple re-ordering of the ten articles within each rule is only cosmetic. They would be missing the point.
Pushing “delivery” to the top is smart as it is the most critical aspect to understand. Clearly defining this point means that the buyer cannot recover against the seller for the loss of or damage to the goods occurring after that point has passed. There is in every Incoterms® rule a place of delivery, a place at which risk transfers from seller to buyer.
And, those eagerly seeking more substantial changes, can rest assured when the DAT was changed DPU (Delivered at Place Unloaded), stressing that the place of destination could be any place and not only a “terminal.”
Be precise with Incoterms® 2020
Given their impact on changes to the delivery of the goods on the one hand and the transfer to risk on the other, you should incorporate the Incoterms® rules as precisely as possible. The best practice is to name the location of the point of delivery in conjunction with the chosen Incoterms® rule.
Be as geographically specific as possible in calling the port, place or point. This is where the goods are “delivered” and this is where the risk transfers from seller to buyer.
Then sense-check what you are writing. CIP Austin, USA, Incoterms® 2020 can work, but FOB Las Vegas Incoterms® 2020 makes little sense, as Las Vegas does not have a maritime port.
Incoterms® and the sales price
Incoterms® are frequently used as price indicators – i.e. “this or that is the EXW, CIF or DDP price,” – and they often refer to a specific formula used in the calculations of the overall price to be charged.
Does using the right Incoterms® 2020 matter that much?
As mentioned before, agreeing to the use of a certain Incoterm® in a sales contract requires a solid understanding of the obligations that a business takes on as a result of agreeing to them. Companies need to ensure they can meet the obligations that come with it before signing any contract.
Can you arrange a carriage to the agreed destination? Have you added the costs of insurance and transport to the sales price? Are you able to customs clear the goods for import as a non-established, foreign seller? How will you get the necessary trade documentation to meet your compliance obligations?
These and many more questions must be answered engaging in international sales or purchases. Failure to understand each term and merely to agree to it can have disastrous consequences for profit margins and order fulfillment, creating supply chain nightmares that must be avoided at all costs.
Why do Incoterms® 2020 matter in the global supply chain?
Incoterms® 2020 should be appreciated as a tool to improve business transactions worldwide. They can prevent disruptions and enhance global supply chain management. They are helping global supply chains to operate smoothly by avoiding bottlenecks over who is responsible for the risks and transportation of purchased goods.
So, how ready are you?
Any organization selling or purchasing goods at a global level should have a clear and deep understanding of Incoterms® 2020. This is the only way to guarantee efficiency and speed in worldwide sourcing and shipping operations. Yet, this requires planning, training, and preparation.