What Are Incoterms & How Do They Impact International Trade?
Incoterms, short for International Commercial Terms, are a set of internationally recognised rules established by the International Chamber of Commerce (ICC). They act as a common language for international trade contracts.
Here’s how Incoterms 2020 impact international trade:
- Clarity On Responsibilities: Incoterms clearly define who (buyer or seller) is responsible for various aspects of the shipment.
- Reduced Risk: By outlining who is responsible for what, Incoterms help manage risks associated with international shipping.
- Smoother Transactions: With a common understanding of responsibilities, Incoterms facilitate smoother international trade transactions.
- Standardised Practices: Incoterms provide a standardised framework for international trade.
How Do Incoterms 2020 Define The Division Of Responsibilities Between Buyers & Sellers?
Incoterms 2020 layout 11 different rules categorised into two categories, each defining responsibilities for buyers and sellers in an international trade contract:
Seller’s Main Obligations: These Incoterms (EXW, FCA, FAS, FOB) place most of the responsibility on the buyer. The seller simply needs to make the goods available at a designated location (EXW) or hand them over to a carrier chosen by the buyer (FCA, FAS, FOB). From that point onwards, the buyer handles all costs and risks associated with transportation, insurance, and customs clearance.
Buyer’s Main Obligations: Conversely, these Incoterms (DAP, DDP, CIP, CPT) shift most of the burden to the seller. The seller takes care of delivering the goods to a designated location in the buyer’s country, often including import clearance and duties (DDP). The buyer is typically responsible for unloading the goods at the final destination.
The following is a table summarising some key aspects of Incoterms and how they divide responsibilities:
| Incoterm | Who Delivers? | Who Pays For Transport? | Who Handles Customs Clearance (Export)? | Who Handles Customs Clearance (Import)? | Risk Transfer Point |
| EXW (Ex Works) | Seller (at their location) | Buyer | Buyer | Buyer | When goods are available at the seller’s location |
| FCA (Free Carrier) | Seller (to buyer’s chosen carrier) | Buyer | Seller | Buyer | When goods are in the buyer’s chosen carrier’s custody |
| FAS (Free Alongside Ship) | Seller (alongside ship at port) | Buyer | Seller | Buyer | When goods are alongside the ship |
| FOB (Free On Board) | Seller (onboard buyer’s chosen vessel) | Buyer | Seller | Buyer | When goods are on board the vessel |
| DAP (Delivered At Place) | Seller (at named place of destination, not unloaded) | Seller | Seller | Buyer | When goods arrive at the named destination |
| DDP (Delivered Duty Paid) | Seller (at the named place of destination, unloaded) | Seller | Seller | Seller | When goods are cleared for import at the named destination |
Which Factors Should Be Considered When Choosing The Appropriate Incoterm For A Transaction?
Several factors come into play when choosing the right Incoterm for the international trade transaction:
- Level Of Experience:
- Seller’s Experience: If the seller has extensive experience with international shipping, they might be comfortable with Incoterms placing more responsibility on them (DAP, DDP).
- Buyer’s Experience: For less experienced buyers, Incoterms like DDP might be preferable, as the seller handles most aspects.
- Relationship Between Parties: For established business relationships, Incoterms with a clearer division of responsibilities (EXW, FOB) might be suitable. For new partnerships, Incoterms like CIP (seller arranges carriage and insurance) can offer a balance.
- Cost Sharing: Incoterms like FOB place most transport costs on the buyer, while DDP puts them on the seller.
- Customs Regulations: Incoterms like DDP involve the seller handling import clearance, which can help navigate complex regulations.
- Risk Management: Consider who should bear the risk of damage or loss during transportation.
How Do Incoterms Interact With Other Trade Documents Like Letters Of Credit?
Incoterms and Letters of Credit (LCs) are both crucial parts of international trade, but they serve different purposes that interact in a specific way:
- Alignment Is Key: Ideally, the chosen Incoterm should be reflected in the documents required by the Letter of Credit. For example, if the Incoterm is FOB (seller loads goods on board), the LC shouldn’t require an “on-board” notation on the bill of lading (which proves the goods are actually on the ship) if it’s not feasible under the FOB terms.
- “C” Incoterms work well: Incoterms like CFR (Cost and Freight), CIF (Cost, Insurance, and Freight), CIP (Carriage and Insurance Paid To), and CPT (Carriage Paid To) work best with Letters of Credit. This is because the seller usually arranges transport and potentially insurance under these Incoterms, and can provide the necessary documents to the bank for payment.
- Focus On documents: Letters of Credit are essentially a ‘documentary transaction’. The bank pays the seller based on the presentation of specific documents outlined in the LC. Incoterms help ensure the seller can obtain these documents by clarifying their responsibilities related to transport and insurance.
What Are The Limitations Of Incoterms And What Other Factors Need To Be Considered In International Logistics?
Incoterms, while incredibly useful for international trade, do have some limitations. Here’s what to keep in mind:
- Limited Scope: Incoterms primarily focus on the delivery of goods, not the entire sale. They don’t address aspects like payment terms, warranties, intellectual property and potential ambiguity.
- Outdated Provisions: Incoterms are updated every 10 years, but rapid changes in logistics and trade practices might leave some provisions outdated.
- Focus On Responsibilities, Not Risk Transfer: While Incoterms define who is responsible for what at specific points, they don’t explicitly determine when the risk of loss or damage transfers between buyer and seller.
Beyond Incoterms, several other aspects are crucial for smooth international logistics:
- Customs Regulations: Each country has its own customs procedures, duties, and potential restrictions. Understanding these is vital for efficient clearance.
- Documentation: Proper and complete documentation is crucial for customs clearance and avoiding delays. This includes commercial invoices, packing lists, certificates of origin, and so on.
- Cultural Awareness: Understanding cultural differences and business practices in your trading partner’s country can prevent misunderstandings and delays.
