If you’ve shipped freight internationally, or even just looked into the possibility, you’ve probably heard the word “incoterm.” But what does it actually mean, and how do you choose which set of incoterms to use? Different incoterms can affect your profit, and it makes more sense to choose one set versus another in some cases. It really depends on your shipment: FOB, EXW, port to door, or port to port all lend themselves to a certain incoterm. It is a good idea to figure out which incoterm is the best one for you.
What are Incoterms?
Incoterms are trade terms published by the ICC (International Chamber of Commerce). According to the ICC, “Incoterms are an internationally recognized standard and are used worldwide in international and domestic contracts for the sale of goods.” They “provide internationally accepted definitions and rules of interpretation for most common commercial terms.”
To simplify things: Incoterms define where the shipping responsibility of your supplier starts, where it ends, and when yours starts.
When do I need to decide which Incoterm to use?
Choose an incoterm to use before you negotiate with the parties involved in your shipment. Some things you might want defined include: Will they pay for the whole shipping? Or will they cover only the first part of the shipping, which can include sending the products or boxes to the freight forwarder’s warehouse or to the airport in the origin country? Or perhaps, you want to pay for the whole shipping cost because you can get better service and rates from a freight forwarder? These are examples of questions you should consider while choosing incoterms.
Which Incoterms should I use?
Imagine that you are the buyer, and you ask your supplier in Taiwan for an order of 100 products. The products need to be delivered in the US. Now you must decide which incoterm you want to use.
Let’s look at some scenarios for the two most common Incoterms: FOB, and EXW.
Scenario 1: FOB – Free on Board
The supplier offers to take care of the all the shipping costs at the origin country, up until the goods reach the departure port. Those costs include the truck delivery from their warehouse to the port, customs clearance, handling charges from the forwarder, and terminal handling charges.
With this offer, you will take responsibility of the freight cost from the origin port until the shipment reaches your door. The costs include the sea freight, the customs clearance in the US, the destination handling charges, the US terminal handling charges, the delivery to your warehouse or the customer’s location, and possibly more.
The Incoterm for this shipping structure is FOB – Free on Board. The ICC defines FOB thusly: ‘“Free On Board” means that the seller delivers the goods on board the vessel nominated by the buyer at the named port of shipment or procures the goods already so delivered. The risk of loss of or damage to the goods passes when the goods are on board the vessel, and the buyer bears all costs from that moment onwards.”
When using FOB incoterm, it is the supplier who makes the first few decisions about your shipment. They can decide whether they will use the origin services from the same forwarder you hire for the sea freight, or they can hire another company to do customs clearance and delivery. However, the basic charges like Handling and Terminal Handling Charges are always paid, in an FOB incoterm, by the supplier to the forwarder.
Some suppliers prefer the FOB Incoterm because they don’t want to negotiate freight rates with forwarders. Others choose FOB because they do not want to keep a track of the shipment. It depends on each company.
FOB also gives you the power to negotiate your rates with the forwarders. However, if you know that your supplier has more negotiation power due to their constant shipments, you can ask them if they can pay the whole shipping cost –and, of course, add it to your account.
Scenario 2: EXW – Ex Works
In this scenario, you as the buyer pay for everything. You hire a forwarder for the airfreight and destination services, but also for the services in the origin country: transportation from the supplier’s warehouse to the port, customs clearance, handling charges, and other costs that may occur. This Incoterm gives you a bit more control over the shipping, but at the same time you have to spend more time in tracking the process at the origin.
The ICC states that Ex Works “means that the seller delivers when it places the goods at the disposal of the buyer at the seller’s premises or at another named place (i.e.,works, factory, warehouse, etc.). The seller does not need to load the goods on any collecting vehicle, nor does it need to clear the goods for export, where such clearance is applicable.”
This Incoterm is very convenient with buyers who already get attractive rates from forwarders. The EXW can also be easier for suppliers who don’t have vendors (such as a customs broker or a favorite trucking company) for the logistics in origin.
FOB and EXW are the most commonly used Incoterms. However, the Incoterm can vary from shipment to shipment, but it is up to the buyer and seller to negotiate the best Incoterm that is convenient for them. It is a good idea to read through the rest of the Incoterms here, and from there you can decide which one works best for you and your supplier.