Why Sometimes Those Letters Really Matter
INCOTERMS specify trading terms and conditions for movement of goods in international trade. They clarify who is responsible for which bills and liable for which losses as merchandise moves around the globe. Who pays to put merchandise on the ship, to stow it, or to take it back off? At what point does "delivery" occur, at the seller's factory door, the buyer's receiving dock, or somewhere in between? Who pays import duties or value added taxes? All of this and more is established by Incoterms and understanding them is critical for anyone negotiating sales contracts and setting corporate trade policy.
The International Chamber of Commerce (ICC) sets the Incoterms and revises them about every ten years. The current Incoterms http://store.iccwbo.org/icc-guide-to-incoterms-2010 come from a revision completed in 2010. Agreeing to an Incoterms rule and incorporating it into a sales contract clarifies the responsibilities for each party to the contract, which is especially important in the case of damage, loss or other problems that can emerge. Knowing what things are going to cost and who is going to pay for what in the shipping process is critical for negotiating successful contracts.
Some rules (EXW, FAC, CPT, CIP, DAT, DAP, and DDP) are for any mode of transport and some rules (FAS, FOB, CFR, and CIF) are for transport by sea and inland waterways only. If a product is containerized, even if it is traveling by ship, the rules for any mode of transport would be used. FAC "Free Carrier" means the risk transfers from the seller to the buyer as soon as the product is turned over to the carrier. FOB "Free on Board" means the risk doesn't transfer until the product is loaded on the ship, not just into the container. Damage can occur to containerized shipments awaiting loading at docks or in the loading process (picture container being dropped into the ocean or crashing into the dock). Exporters avoid that risk using FAC rather than FOB.
Another way to break down the rules is by who pays for the main transport. If the buyer pays for all of it, then EXW is used. If the buyer arranges main transport then FAS, FOB, or FCA are used. If the seller arranges the main carriage and doesn't transfer risk to the buyer until that is complete, DAT, DAP or DDP are used. If the seller makes the arrangements, but the risk transfers to the buyer before main transport, then CFR, CIF, CPT or CIP would be used.
Buyers may be surprised by the terms starting with C. The seller may be paying for transport, but the risk is transferred to the buyer long before local delivery. So an importer receiving a shipment CPT, CFR, CIF or CIP to Long Beach, California, under Incoterms 2010, actually accepted risk from the exporter at the point the product was delivered as specified at the foreign port. And the major difference between these terms is about whether the seller paid insurance to cover that shipment. The insurance benefits the buyer and the buyer would make the claim under CIP or CIF. CPT or CFR there is no insurance unless the buyer purchases it separately to cover the risk exposure. Even if insurance is paid, it may be minimal so buyers may want to specify coverage levels in their contracts. As I tell my students, it matters which Incoterm you used and how much insurance coverage was paid for if the Somali pirates or bad weather cause loss.
Here are just a few other things to keep in mind when selecting Incoterms. While risk transfers based on Incoterms, title does not so the issue of title transfer should be clarified in sales documents. Required documents and formalities may make it extremely difficult for an importer to complete the work necessary to accept EXW "Ex Works," or for the seller to pay all the necessary fees in the importing country to offer DDP "Delivered Duty Paid." Often, more than one carrier is involved in transport, and a buyer may not be comfortable accepting risk from the first local-hauler providing transportation. The specific place risk will transfer should be clear. Letters of credit and other forms of documentary collection may necessitate the use of particular Incoterms to meet the needs of the banks involved.