Incoterms Explained: Definition, Examples, Rules, Pros & Cons

What Are Incoterms?

To facilitate commerce around the world, the International Chamber of Commerce (ICC) publishes a set of Incoterms, officially known as international commercial terms. Globally recognized, Incoterms prevent confusion in foreign trade contracts by clarifying the obligations of buyers and sellers.

Parties involved in domestic and international trade commonly use them as a kind of shorthand to help understand one another and the exact terms of their business arrangements. Some Incoterms apply to any means of transportation, while others apply strictly to transportation across water.

Understanding Incoterms

The International Chamber of Commerce (ICC) developed Incoterms in 1936 and updates them periodically to conform to changing trade practices. The ICC's mission is to promote open markets and ensure global economic prosperity through trade. Because it is a networked business organization that reaches over 45 million companies in 100 countries, the ICC is seen as having unparalleled expertise in establishing rules to guide international trade. While the adherence to its Incoterms is voluntary, the ICC-established rules are commonly used by buyers and sellers as a regular part of trade transactions.

Incoterms provide a universal set of rules and guidelines that help facilitate trade. In essence, they provide a common language traders can use to set the terms for their trades. Buyers and sellers can use Incoterms in a variety of activities necessary to conduct business. Typical activities that call for the use of Incoterms include filling out a purchase order, labeling a shipment for transport, completing a certificate of origin, or documenting a free carrier agreement (FCA).

Incoterms Rules for Any Mode of Transport

Some common examples of Incoterms rules for any mode of transportation include Delivered Duty Paid (DDP), Delivered at Place (DAP), and Ex Works (EXW). The seven Incoterms for any mode of transport are below:

• 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

DPU indicates the seller delivers the goods to a terminal and assumes all the risk and transportation costs until the goods have arrived and been unloaded. After that, the buyer assumes the risk and transportation costs of the goods from the terminal to the final destination.

DDP indicates the seller assumes all the risk and transportation costs. The seller must also clear the goods for export at the shipping port and import at the destination. Moreover, the seller must pay export and import duties for goods shipped under DDP.

Under Incoterm Ex Works (EXW), the seller is only required to make the goods available for pickup at the seller's business location or another specified location. Under EXW, the buyer assumes all the risk and transportation costs.

In 2010, the two main categories of Incoterms were updated and classified by modes of transport. The first classification applies to any mode of transport, while the second classification only applies to sea and inland waterway transport.

Incoterms Rules for Sea and Inland Waterway Transport

The ICC has specific Incoterms rules for inland waterway and sea transport such as cost, insurance, and freight (CIF) and free on board (FOB). The Incoterms for sea and inland waterway transport are below:

• FAS: Free Alongside Ship
• FOB: Free on Board
• CFR: Cost and Freight
• CIF: Cost, Insurance, and Freight

Free on-board shipment terms indicate the seller delivers the goods on board a designated vessel named by the buyer. The buyer or seller may assume all the risk and transportation costs depending on whether the goods are sold under the FOB shipping point or FOB destination point.

Cost, insurance, and freight (CIF) terms indicate the seller must deliver the goods to a designated port and load them on a specified vessel, assuming responsibility for paying all transportation, insurance, and loading costs. After that, the buyer assumes the cost and risk associated with transporting the cargo from the designated port to its warehouse or business.

What Do Incoterms Not Cover?

There are specific instances that Incoterms will not cover. Incoterms do not:

• Address all the conditions of a sale 
• Identify the goods being sold nor list the contract price
• Reference the method nor timing of payment negotiated between the seller or buyer   
• When title, or ownership of the goods, passes from the seller to the buyer  
• Specify which documents must be provided by the seller to the buyer to facilitate the customs clearance process at the buyer’s country  
• Address liability for the failure to provide the goods in conformity with the contract of sale, delayed delivery, nor dispute resolution mechanisms

Due to the omission of certain sale conditions, only working with Incoterms can be constricting. All parties involved in any contract should make sure all the applicable instances above are addressed before signing the contract. Many legal matters can arise due to working only with Incoterms, which is why you should address all the above reasons to ensure smooth business.

Incoterms 2010 vs. Incoterms 2020

Although Incoterms were updated in 2020, there are no significant differences between the naming of the two. There was only one change in the terminology and that was the 2010 term Delivered at Terminal (DAT) was clarified to the 2020 term Delivered at Place Unloaded (DPU). This was to include all places of unloading, not only those done in terminals. In both instances, there are 11 terms.

Things become more involved when you move past the terms themselves. For example, the amount of freight insurance required under the CIP term has been increased. However, this does not have an effect on the CIF term.

Incoterms 2020 covers situations where either the buyer or seller transports goods using their own vehicles. In 2010, it was assumed that these services were provided by a third-party carrier. There is a change in the way that the FCA rule is used in conjunction with a letter of credit.

In addition, there are security-related cost responsibilities that have been changed. These can be associated with export clearance processes as well as the import clearance process. The Incoterms revision clarified that the most common cost headings are those associated with transport that are the responsibility of the party who arranges this. Security costs associated with export clearance will be borne by the seller other than for Ex Works cases. Security costs associated with import will be borne by the buyer, except for DDP cases.

Advantages and Disadvantages of Incoterms

The single greatest advantage of using Incoterms is the standardization and specificity of complicated international trade aspects. Having a system that eliminates ambiguity between nations has made trading much more simple, especially when negotiating terms. This saves time and money that would have previously been spent on lawyers who would draft terms basically breaking down Incoterms into different language.

A notable disadvantage to Incoterms is that buyers and sellers will have different preferences when using them. For example, sellers may choose CIF because they understand their shipments in a better way than buyers. The buyer, in contrast, may prefer FOB for the same reasons. However, the terms themselves are not the issue and it becomes more a matter of negotiation over which terms to use versus the clarity of the terms themselves.

Frequently Asked Questions

The Bottom Line

Incoterms are helpful terms used to facilitate international trade. They are separated by modes of transport between any mode, and those specifically involving water transport. The terms categorize responsibility between the buyer and seller but there are some aspects of trade that the terms do not cover, such as the goods being sold or future liability responsibilities. For this reason, Incoterms should be used to help clarify agreements, and should not be the entirety of the agreement.