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Incoterms explained: Meaning, types, usage, and benefits

Incoterms are trade terms published by the International Chamber of Commerce that define the responsibilities of sellers and buyers. Learn more about Incoterms in this blog.

International trade can be complex, and confusion over who handles shipping, insurance, customs, etc. can lead to disputes and delays. To avoid misunderstandings, the International Chamber of Commerce (ICC) has developed a standardized set of trade rules known as Incoterms, which define the buyer and seller's key responsibilities in an international trade transaction. In this blog post, we will explore what Incoterms are, their types, usage, and the benefits they offer.

What are Incoterms?

Incoterms (short for International Commercial Terms) are a series of globally recognized trade rules established by the International Chamber of Commerce (ICC). They define the responsibilities of sellers and buyers in international trade transactions. Incoterms were first introduced in 1936 and are updated periodically to reflect changes in global trade practices. In 2010, Incoterms were categorized into two groups based on modes of transport: a) those applicable to any mode of transport, and b) those specific to sea, land or inland waterway transport.

What are Incoterms 2020?

Incoterms 2020 is the latest version of the Incoterms that reflects modern trade practices and provides enhanced clarity on buyer-seller responsibilities. It includes 11 terms that outline key responsibilities, precisely stating obligations related to shipping, customs clearance, risk transfer, etc.¹

Key changes made in new Incoterms 2020

The Incoterms 2020 brought some crucial changes to international trade. Here are some of the most significant updates:

● Delivered at Terminal (DAT) clause was replaced by Delivered at Place Unloaded (DPU) clause, allowing delivery at any place, not just at a terminal like an airport or port terminal.
● The FCA (Free Carrier) Incoterm allows sellers to obtain bills of lading from the carrier after loading, which is an important change for exporters operating under letters of credit.
● The CIP (Carriage and Insurance Paid To) and CIF (Cost, Insurance, and Freight) terms were updated, setting different minimum insurance levels, ensuring more appropriate coverage in line with industry standards.²

Uses of Incoterms in international trade

Incoterms serve as a set of universal rules and guidelines for international trade and shipping. They clarify the responsibilities of both sellers and buyers regarding freight costs, insurance, export and import duties, risk management, etc.

The following are some ways in which Incoterms are used in modern international trade:
● Defines responsibility: Incoterms define who shall be responsible for the transport of goods, its insurance, and customs clearance.
● Outlines risk transfer: Incoterms specify the point at which the risk of loss or damage to goods transfers from seller to buyer.
● Ensures consistency: Incoterms help prevent disputes and misunderstandings in global trade.

Advantages of Incoterms

Following are some advantages of Incoterms:

Simplifies international trade

Incoterms remove ambiguity between countries, streamlining trade processes and reducing delays or unexpected expenses.

Defines responsibilities

Incoterms clarify the roles of buyers and sellers, detailing what they must do, pay for, and manage, ensuring smoother and more efficient transactions.

Disadvantages of Incoterms

Below are a few disadvantages of Incoterms:

Negotiation challenges

While Incoterms themselves are clear, differing preferences between buyers and sellers can make negotiations more complex, as each party advocates for terms that better align with their interests. For example, sellers may prefer CIF (Cost, Insurance, and Freight) because it gives them greater control over shipments while buyers might favor FOB (Free on Board) as it allows them to manage the shipment from an earlier stage.

Impact on transactions

Disputes over which Incoterms to use can shift the focus from its primary purpose of ensuring efficiency, complicating negotiations and decision-making.

Types of Incoterms

There are 11 Incoterms, which fall into two categories: first, those applicable to all modes of transport; and second, those used exclusively for sea and inland waterway transport.

Incoterms used for any transport

Incoterms which apply to all modes of transportation, air, road, rail, and sea, are as follows:

● Ex Works (EXW): The buyer takes on the cost and risk of transport once the goods leave the seller's premises.
● FCA (Free Carrier): The seller delivers the goods to a carrier at the specified location, with risk transferring to the buyer thereafter.
● CPT (Carriage Paid To): The seller pays for transport to a specified destination. Once the goods are handed over to the first carrier, the risk transfers to the buyer.
● CIP (Carriage and Insurance Paid to): Similar to CPT, but the seller provides insurance against loss or damage to the goods during transit until they reach the final destination.
● DAP (Delivered at Place): Goods are delivered to a destination by the seller; unloading is at the buyer's risk.
● DPU (Delivered at Place Unloaded): The seller delivers the goods, but the buyer takes on the risk during unloading.
● DDP (Delivered Duty Paid): The seller covers all risks and costs of transporting goods to the buyer's premises, including import duties.

Incoterms used only for sea and inland waterway transport

The following Incoterms are specific to sea and inland waterway transport:

● FAS (Free Alongside Ship): The seller places the goods next to the ship, and the buyer assumes all responsibility from that point onward.
● FOB (Free on Board): The seller delivers the goods onto the ship; from that point, the buyer takes responsibility for the goods and assumes all.
● CFR (Cost and Freight): The seller pays for transportation to the destination port, but the risk transfers to the buyer once the goods are loaded onto the ship.
● CIF (Cost, Insurance, and Freight): The seller covers the transportation and insurance costs until the goods reach the port of destination.⁵

What’s the difference between Incoterms 2020 and 2010?

Incoterms 2010

Incoterms 2020

The seller was not entitled to an on-board bill of lading, which was typically issued to the buyer once the goods were handed to the carrier, without an on-board notation.

The seller can request the carrier to issue an on-board bill of lading after the goods are loaded, which is particularly useful in letter of credit transactions.

DAT (Delivery at Terminal) required the seller to deliver and unload goods at a terminal.

DAT is replaced by DPU (Delivered at Place Unloaded) which broadens the delivery point to any location, not just a terminal.

CIP (Carriage and Insurance Paid to), which imposes insurance requirements, required the seller to provide insurance with at least Institute Cargo "C" Clauses coverage.

CIP now requires the seller to provide insurance with Institute Cargo “A” Clauses coverage, offering broader protection.

The responsibility for carriage of goods was typically determined by the specific Incoterm being used.

Terms like FCA, DAP, DPU, and DDP allow either the seller or the buyer to perform the carriage of goods, with the responsibility to "contract or arrange at its own cost for the carriage of goods from the named place of delivery.⁶

What do Incoterms not cover?

Incoterms have limitations as they do not cover all conditions of a sale, including:

● Identifying the products being sold or listing the contract price.
● Referencing the method or timing of payment agreed upon between the seller and buyer.
● Determining when the title or ownership of the goods transfers from the seller to the buyer.
● Specifying necessary documents for customs clearance in the buyer's country.
● Addressing liability for failure to provide goods as per the sale contract, delayed delivery, or dispute resolution mechanisms.

Relying solely on Incoterms can be restrictive due to these omitted sale conditions. To ensure a smooth business transaction, all involved parties should ensure that these aspects are addressed before signing the contract.

Tips for using Incoterms

Here are a few tips to ensure that Incoterms are applied correctly during international trade:

● Choose the right Incoterm: Select the most appropriate Incoterm in light of the mode of transport and the level of risk you want to take on for your transaction.
● Understand responsibilities: Recognize the obligations under each Incoterm, including those about customs charges, insurance, and shipping expenses.
● Include Incoterms in contracts: Always include your selected Incoterm in writing in your sales contract; this will protect you legally and prevent any misunderstandings down the road.
● Stay updated on revisions: Consider Incoterms 2020, for instance; be aware of the revisions to stay up to date with the most recent advancements.

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More blogs on incoterms

1. What is Delivered at Terminal (DAT) incoterm?

2. What is a Cost and Freight (CFR) incoterm?

3. All you need to know about Free Alongside Ship (FAS) incoterm 2020

4. Guide to FCL shipping: Everything exporters need to know

5. What is Carriage Insurance Paid (CIP) in incoterms?

6. What is Freight on Board: How does it work in shipping?

7. What is a Container Freight Station (CFS) and its role in shipping?

8. What is Cost, Insurance and Freight (CIF) in shipping?

9. What is a Free Carrier (FCA) incoterm?

10. What is EX Works (EXW) incoterm in international trade?

Frequently Asked Questions

1. Can I still use Incoterms 2010 after Jan 1, 2020?

Yes, all contracts using Intercoms are valid if they are agreed by the parties involved and identified in related export documents.

2. Why are Incoterms used?

Incoterms prevent confusion in foreign trade contracts by clarifying the obligations of both customers or importers and sellers or exporters.

3. Who publishes Incoterm rules?

Incoterms are published by the International Chamber of Commerce. It was first established in 1936, while the latest version was published in 2020.

4. What is the purpose of Incoterms?

Incoterms provide information about responsibilities of parties involved in international trade like paying and managing shipment, insurance, documentation, customs clearance and other logistics.

5. How do Incoterms help in international trade?

Incoterms prevent confusion in foreign trade contracts and clarify the obligations of buyers and sellers.

6. What are the Incoterms for air freight?

For air freight, the most commonly used Incoterms are EXW (Ex Works), FCA (Free Carrier), CPT (Carriage Paid To), and CIP (Carriage and Insurance Paid To). These terms are versatile and apply to all modes of transport, including air. They define the responsibilities for transportation, insurance, and risk transfer between the buyer and seller.

Published on July 19, 2022.

Sources:
1. https://www.trade.gov/know-your-Incoterms#:~:text=An%20Overview%20of%20Incoterms%C2%AE,of%20goods%20in%20international%20transactions.
2. https://www.rcm.si/en/Incoterms-2020-7-key-changes#:~:text=The%20Delivered%20at%20Terminal%20(DAT,anywhere%2C%20not%20just%20a%20terminal.
3. https://www.investopedia.com/terms/i/Incoterms.asp
4. https://www.hst.nl/en/incoterm/
5. https://maritimelogs.com/resources/Incoterms/sea-inland-waterway/
6. https://www.marsh.com/en/industries/cargo/insights/Incoterms-2010-replaced-with-Incoterms-2020.html
7. https://www.maersk.com/logistics-explained/customs-and-compliance/2023/10/04/how-to-avoid-the-7-most-common-incoterm-mistakes

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