Learning Outcomes

By the end of this lesson, learners should be able to:

• Explain the meaning and purpose of Incoterms.
• Describe the role of Incoterms in international sales contracts.
• Explain the responsibilities of buyers and sellers under different Incoterms.
• Distinguish between costs, risks, and responsibilities in international trade transactions.
• Explain how Incoterms determine the point at which risk transfers from seller to buyer.
• Differentiate between Incoterms used for different modes of transport.
• Explain the responsibilities associated with transportation, insurance, export clearance, and import clearance.
• Apply appropriate Incoterms to practical international trade situations.
• Identify common misunderstandings associated with Incoterms.
• Explain how Incoterms affect logistics planning, pricing, customs procedures, and international trade risk.

Introduction

International trade transactions involve much more than agreeing on the price of goods. Buyers and sellers must also determine who will arrange transportation, who will pay freight charges, who will obtain insurance, who will handle export and import formalities, where the goods will be delivered, and at what point the risk of loss or damage transfers from one party to the other.

If these responsibilities are not clearly defined, disagreements can arise between the buyer and seller. A seller may believe that transportation to a particular destination is its responsibility, while the buyer may assume that the seller is responsible for all costs and risks until the goods reach the buyer’s warehouse.

Incoterms, short for International Commercial Terms, provide standardized rules that help define important responsibilities between buyers and sellers in international trade contracts.

Incoterms are published by the International Chamber of Commerce (ICC). They provide a common framework for interpreting certain delivery obligations in international sales transactions.

Incoterms do not replace the sales contract. Instead, they complement the contract by clarifying specific responsibilities relating to delivery, costs, risk, transportation, insurance, and certain customs formalities.

Meaning of Incoterms

Incoterms are standardized international trade rules that define certain responsibilities of buyers and sellers in the delivery of goods.

They help answer questions such as:

• Who arranges transportation?
• Who pays transportation costs?
• Who handles export clearance?
• Who handles import clearance?
• Who obtains insurance under terms where insurance is required?
• Where does delivery occur?
• When does risk transfer from seller to buyer?
• Who bears certain costs associated with delivery?

Incoterms do not answer every question in an international sales contract. They should therefore be used together with clear contractual terms covering matters such as price, payment, product quality, ownership, warranties, dispute resolution, and applicable law.

Purpose of Incoterms

The primary purpose of Incoterms is to create a common language for international delivery obligations.

International transactions often involve parties from different countries with different legal systems, commercial practices, and languages. Standardized terminology reduces ambiguity.

For example, if a contract states that goods are sold under an appropriate Incoterm and identifies the agreed place, the parties have a common reference point for determining certain delivery obligations.

Why Incoterms Are Important

Incoterms influence the cost and risk structure of international transactions.

A buyer comparing two suppliers may receive one quotation on a delivered basis and another on a shipment basis. The prices cannot be compared properly without understanding what transportation, insurance, customs, and other costs are included.

For example, a supplier offering goods at $50,000 under one Incoterm may actually represent a higher total landed cost than a supplier offering the same goods for $54,000 under another Incoterm.

Understanding Incoterms therefore helps businesses make better purchasing and selling decisions.

Incoterms and the Sales Contract

An Incoterm should normally be incorporated clearly into the sales contract or commercial agreement.

A good reference generally identifies:

Chosen Incoterm + named place + applicable version where appropriate

For example, a contract may specify an Incoterm together with a clearly identified delivery location.

Simply writing “FOB” or “CIF” without identifying the relevant location can create unnecessary ambiguity.

Incoterms and Risk

One of the most important concepts in Incoterms is risk transfer.

Risk refers to responsibility for loss of or damage to the goods during the transportation or delivery process.

The point at which risk transfers depends on the selected Incoterm.

Importantly, the point where the seller pays costs is not necessarily the same point where risk transfers.

This distinction is one of the most common areas of misunderstanding among people new to international trade.

Costs Versus Risk

Consider a transaction where the seller agrees to pay transportation to the buyer’s destination.

It may seem logical to assume that the seller therefore carries the risk throughout the journey.

However, some Incoterms require the seller to pay transportation beyond the point where risk has already transferred to the buyer.

Therefore, businesses must separately analyze:

Who pays?

and

Who bears the risk?

These are not always the same party.

Incoterms and Ownership

Incoterms generally do not determine when ownership or title to the goods transfers.

Ownership is normally addressed separately in the sales contract and under applicable law.

A buyer should therefore not assume that the point of risk transfer automatically determines the point of ownership transfer.

Incoterms 2020

The current edition of the ICC’s Incoterms rules is Incoterms 2020.

The rules contain 11 Incoterms divided broadly into:

• Rules for any mode or modes of transport.
• Rules specifically for sea and inland waterway transport.

Businesses should specify the intended version in their contracts where appropriate and ensure that employees and trading partners understand which rules are being applied.

Incoterms for Any Mode of Transport

The Incoterms that can generally be used for any mode or combination of modes of transport are:

• 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.

These rules can be used for road, rail, air, sea, or multimodal transportation, subject to the specific requirements of each rule.

Incoterms for Sea and Inland Waterway Transport

The Incoterms designed specifically for sea and inland waterway transport are:

• FAS – Free Alongside Ship.
• FOB – Free On Board.
• CFR – Cost and Freight.
• CIF – Cost, Insurance and Freight.

These terms are particularly relevant to traditional maritime shipment structures.

Ex Works (EXW)

Under EXW, the seller generally makes the goods available at a specified location, such as the seller’s premises.

The buyer takes on a significant portion of the transportation and related responsibilities.

Under EXW, the buyer may be responsible for arranging transportation from the seller’s premises, export formalities where applicable, main carriage, import clearance, and delivery to the final destination.

Example of EXW

Imagine a Kenyan importer purchasing machinery from a supplier in another country under EXW terms.

The supplier makes the machinery available at its factory.

The buyer must arrange collection, transportation, and the other responsibilities assigned under the selected term.

The buyer therefore has substantial control over the logistics process but also carries substantial responsibility.

Advantages of EXW

EXW can be attractive to sellers because the seller’s delivery responsibility is relatively limited.

The buyer may benefit when it has strong logistics capabilities and can negotiate competitive transportation arrangements.

However, EXW may not always be the most practical choice for international transactions because export clearance and other activities can create complications depending on the country and circumstances.

Free Carrier (FCA)

Under FCA, the seller delivers the goods to the carrier or another person nominated by the buyer at the agreed location.

The exact responsibilities differ depending on whether delivery occurs at the seller’s premises or another named location.

FCA is widely useful for international and multimodal transactions.

Example of FCA

Suppose an exporter sells goods under FCA at its warehouse.

The seller prepares the goods and delivers them to the carrier at the agreed location after completing the responsibilities assigned to the seller under the rule.

The buyer then takes responsibility for the subsequent transportation according to the agreed arrangement.

FCA can provide a more practical structure than EXW for many international transactions because it can allocate export-related responsibilities more appropriately.

Carriage Paid To (CPT)

Under CPT, the seller arranges and pays for carriage to the named destination.

However, risk transfers to the buyer when the goods are delivered to the carrier in accordance with the rule, rather than when the goods arrive at the final destination.

This creates an important distinction between payment of carriage and transfer of risk.

Example of CPT

A seller in Country A agrees to sell goods to a buyer in Country B under CPT to a named destination.

The seller contracts and pays for transportation to that destination.

However, the buyer assumes the risk at the point specified by the CPT rule when the goods are handed over to the carrier.

Therefore, the seller can be paying transportation costs while the buyer already carries the transit risk.

Carriage and Insurance Paid To (CIP)

CIP is similar to CPT because the seller arranges and pays for carriage to the named destination.

However, under CIP, the seller also has an insurance obligation meeting the requirements of the Incoterm.

The seller’s insurance responsibility is an important difference between CPT and CIP.

CIP and Insurance

Insurance requirements under CIP are an important consideration for buyers and sellers.

The parties should understand what level of coverage is required under the applicable Incoterms version and whether additional insurance is appropriate for the particular cargo.

High-value or sensitive goods may require careful evaluation of insurance coverage beyond simply assuming that the minimum contractual insurance requirement provides complete protection.

Delivered at Place (DAP)

Under DAP, the seller delivers the goods to the agreed destination when the goods are placed at the disposal of the buyer on the arriving means of transport, ready for unloading.

The seller generally bears the costs and risks of transportation to that point.

The buyer generally handles unloading and import clearance responsibilities under the rule.

Example of DAP

Suppose a supplier agrees to deliver machinery to a buyer’s warehouse under DAP.

The seller arranges transportation to the agreed destination.

The goods arrive at the buyer’s location and are made available for unloading.

The buyer is generally responsible for unloading and completing import clearance responsibilities.

DAP can be useful when a seller wants to offer a delivered service without taking responsibility for import clearance and import duties.

Delivered at Place Unloaded (DPU)

DPU is distinctive because the seller delivers the goods at the named destination unloaded.

The seller therefore has responsibility for unloading at the agreed destination.

After unloading, the buyer takes on the responsibilities assigned to it under the rule.

DPU Versus DAP

The key distinction is the unloading responsibility.

Under DAP, the seller delivers the goods ready for unloading.

Under DPU, the seller delivers the goods after unloading them at the named destination.

This difference is important when the unloading process requires specialized equipment, labor, or significant costs.

Delivered Duty Paid (DDP)

DDP places a very high level of responsibility on the seller.

The seller generally handles delivery to the named destination and is responsible for export and import formalities and applicable import duties and taxes as specified by the rule.

The buyer generally has fewer responsibilities than under most other Incoterms.

Example of DDP

Suppose an international supplier sells equipment to a customer under DDP to the customer’s premises.

The seller organizes the international transportation, handles the required customs formalities, and bears the applicable duties and taxes under the term.

The buyer receives the goods at the agreed destination subject to the responsibilities specified by the contract and rule.

DDP can be attractive to buyers because it provides a more comprehensive delivered price.

However, sellers must carefully assess whether they can legally and practically handle import formalities and taxes in the destination country.

Risks Associated with DDP

DDP can expose the seller to significant responsibilities.

A seller may face challenges involving:

• Import licensing.
• Local customs requirements.
• Import taxes.
• Local representation.
• Regulatory requirements.
• Tax registration.
• Destination-country laws.

For this reason, businesses should not select DDP simply because customers prefer a delivered price.

Free Alongside Ship (FAS)

FAS is a sea and inland waterway rule.

The seller delivers the goods alongside the vessel nominated by the buyer at the agreed port of shipment.

The buyer generally assumes risk once the goods are placed alongside the vessel according to the rule.

FAS can be appropriate for certain bulk or specialized cargo arrangements.

Free on Board (FOB)

FOB is another sea and inland waterway rule.

Under FOB, the seller delivers the goods on board the vessel nominated by the buyer at the agreed port of shipment.

Risk transfers when the goods are on board the vessel according to the rule.

Example of FOB

Suppose a buyer purchases agricultural commodities from an overseas supplier under FOB at the seller’s port.

The seller is responsible for getting the goods through the relevant export process and loading them on board the nominated vessel as required by the rule.

Once the goods are on board, risk transfers to the buyer.

The buyer then manages the main carriage and subsequent responsibilities.

FOB and Container Shipments

One important practical consideration is that FOB is designed for sea and inland waterway transport where goods are delivered on board the vessel.

For many containerized shipments, goods are handed over to a carrier at a container terminal before they are loaded onto the vessel.

In such situations, FCA may often be more appropriate than FOB because it can better reflect the actual point at which the seller delivers the goods to the carrier.

Cost and Freight (CFR)

Under CFR, the seller arranges and pays the cost and freight necessary to bring the goods to the named port of destination.

However, risk transfers to the buyer when the goods are loaded on board the vessel at the port of shipment.

Therefore, as with CPT, the seller pays for transportation beyond the point where risk has transferred.

Example of CFR

A seller exports a shipment under CFR to a named destination port.

The seller pays the ocean freight to the destination port.

However, once the goods are loaded on board the vessel at the origin port, the buyer bears the transit risk.

This is why the buyer may need to arrange appropriate cargo insurance.

Cost, Insurance and Freight (CIF)

CIF is similar to CFR but includes an insurance obligation for the seller.

The seller arranges and pays for transportation to the named destination port and obtains insurance according to the requirements of the Incoterm.

Risk still transfers when the goods are loaded on board the vessel at the shipment port.

CIF and Insurance

CIF is frequently used in international commodity and maritime trade.

However, buyers should understand the actual level of insurance required and consider whether additional coverage is appropriate.

The existence of an insurance obligation does not automatically mean that every possible loss is fully covered.

Comparison of Major Incoterms

The table provides a simplified overview. Businesses should always consult the complete applicable Incoterms rule and contract terms before making a transaction decision.

Incoterms and Transportation Costs

Incoterms affect the allocation of transportation costs.

A seller may quote a lower price under EXW because the buyer is responsible for much of the transportation.

The same seller may quote a higher price under DDP because the seller is taking responsibility for substantially more transportation and import-related costs.

Therefore, comparing prices without considering the Incoterm can produce misleading conclusions.

Landed Cost

Landed cost represents the total cost of obtaining goods at their intended destination.

It can include elements such as:

Purchase price + transportation + insurance + customs duties + taxes + handling + clearance + storage + other applicable costs

The actual components vary by transaction.

Incoterms help determine which party is responsible for specific elements of the overall cost.

Example of Landed Cost Comparison

Suppose Supplier A offers machinery for $100,000 under EXW.

Supplier B offers similar machinery for $112,000 under DAP.

The buyer should not immediately conclude that Supplier A is cheaper.

The buyer needs to calculate transportation, insurance, customs clearance, duties, taxes, unloading, and other costs under each arrangement.

After calculating the total landed cost, Supplier B may actually provide the lower overall cost.

Incoterms and Insurance

Insurance responsibilities differ among Incoterms.

CIP and CIF include insurance obligations for the seller.

Other Incoterms generally do not impose a seller insurance obligation, although either party may choose to obtain insurance based on the risk it bears.

Insurance should therefore be considered separately from the basic question of who pays transportation.

Incoterms and Customs

Incoterms allocate certain responsibilities for export and import formalities.

In general, the seller handles export formalities under many Incoterms, while the buyer handles import formalities under most terms.

DDP is a major exception because the seller takes on import clearance responsibilities and applicable import duties and taxes under the rule.

Businesses must ensure that the party assigned a customs responsibility can actually perform it legally and operationally.

Incoterms and Import Duties

Import duties are generally associated with the import process.

Under most Incoterms, the buyer is responsible for import clearance and applicable import duties and taxes.

Under DDP, the seller takes on these responsibilities under the rule.

This difference can significantly affect the seller’s pricing and risk exposure.

Incoterms and Export Clearance

Export clearance is generally the seller’s responsibility under the Incoterms rules, although the specific responsibilities depend on the selected term.

Businesses should ensure that the exporter is legally able to complete the required export formalities.

Incoterms and Documentation

The selected Incoterm can influence which party needs to arrange or provide certain transportation and delivery documentation.

However, Incoterms do not eliminate other documentation requirements imposed by customs, regulators, banks, carriers, or the sales contract.

Incoterms and Freight Forwarders

Freight forwarders can help parties implement transportation arrangements associated with an Incoterm.

For example, a seller responsible for arranging international transportation may appoint a freight forwarder to coordinate the shipment.

The freight forwarder can arrange bookings, prepare documentation, coordinate cargo movement, and communicate with carriers.

Incoterms and Freight Negotiation

The party responsible for arranging main carriage often has greater control over freight negotiations.

A large buyer may prefer an Incoterm that allows it to control transportation because it has negotiated favorable freight rates.

A smaller buyer may prefer the seller to arrange transportation because the seller has stronger relationships with carriers.

The best Incoterm therefore depends partly on the logistics capabilities of the parties.

Incoterms and Supply-Chain Control

The choice of Incoterm can affect supply-chain visibility and control.

When the buyer controls transportation, it may have greater control over carrier selection, routing, tracking, and scheduling.

When the seller controls transportation, the buyer may have less direct control but may benefit from simpler purchasing arrangements.

Incoterms and Risk Management

Businesses should select Incoterms based on their ability to manage the risks associated with the transaction.

A company with strong logistics capabilities may prefer to control transportation.

A company with limited international logistics experience may prefer a more seller-managed delivery arrangement.

Risk should be evaluated together with cost, control, compliance, and operational capability.

Incoterms and Payment Terms

Incoterms and payment terms are separate concepts.

A transaction may use an Incoterm such as CIF while also using a letter of credit, documentary collection, open account, or another payment method.

The parties should therefore specify both delivery terms and payment arrangements.

Incoterms and Letters of Credit

In documentary trade finance, the selected Incoterm can influence the documents required under a letter of credit.

For example, if a transaction requires a particular transport document or insurance document, the seller must ensure that the documentation corresponds with the contractual requirements.

Documentary discrepancies can cause payment problems even when the physical shipment has been completed.

Common Incoterms Misunderstandings

Several misunderstandings frequently occur.

One is assuming that the party paying transportation automatically bears the risk throughout transportation.

Another is assuming that Incoterms determine ownership.

Another is using an Incoterm without specifying a precise named location.

A further misunderstanding is believing that an Incoterm automatically covers every contractual issue.

These misconceptions can create significant commercial disputes.

Misunderstanding: “Seller Pays Everything”

A buyer may assume that a delivered Incoterm means the seller is responsible for every possible cost.

This is incorrect.

Each Incoterm assigns specific responsibilities, and additional costs may fall outside the basic delivery obligations.

The sales contract should therefore clearly identify other relevant financial responsibilities.

Misunderstanding: “Incoterms Determine Ownership”

Incoterms primarily address delivery obligations, costs, and risk.

Ownership or title should be addressed separately.

A business should therefore ensure that the sales contract contains clear ownership provisions.

Misunderstanding: “Insurance Means Everything Is Covered”

Where an Incoterm requires the seller to obtain insurance, the buyer should still understand the scope and conditions of the coverage.

Insurance policies contain exclusions, limits, deductibles, and other conditions.

Additional coverage may be necessary depending on the cargo and risk profile.

Selecting an Appropriate Incoterm

A business should consider several factors before selecting an Incoterm.

These include:

• Mode of transportation.
• Transportation capability.
• Customs capability.
• Insurance requirements.
• Risk tolerance.
• Freight rates.
• Destination-country requirements.
• Import licensing.
• Export requirements.
• Desired control over logistics.
• Customer expectations.
• Total landed cost.

Example: Selecting an Incoterm for Machinery

A manufacturer in one country sells expensive machinery to a customer in another country.

The seller has extensive international logistics experience and has negotiated favorable freight rates.

The buyer has limited experience with international transportation and prefers a delivered arrangement.

The parties may consider an appropriate delivered Incoterm such as DAP, provided the allocation of customs and other responsibilities works for both parties.

The seller can manage the transportation while the buyer manages the responsibilities assigned to it.

Example: Selecting an Incoterm for Containerized Cargo

A buyer purchases containerized goods from an overseas supplier.

The buyer has a strong relationship with a freight forwarder and wants control over international freight.

Rather than automatically choosing FOB because the shipment is transported by sea, the parties may evaluate FCA where the goods are handed over to the buyer’s nominated carrier at the appropriate location.

This may better reflect the actual logistics process for containerized cargo.

Example: Choosing Between CIF and CFR

An importer purchases bulk goods transported by sea.

Under CFR, the seller pays the ocean freight but does not have the same seller insurance obligation as under CIF.

Under CIF, the seller arranges the required insurance in addition to paying freight.

The buyer should compare the commercial pricing and insurance arrangements to determine which option better meets its requirements.

Incoterms and Strategic Procurement

Procurement professionals should not treat Incoterms as a minor contractual detail.

The selected term can affect:

• Supplier pricing.
• Transportation control.
• Working capital.
• Inventory planning.
• Insurance.
• Customs responsibilities.
• Risk exposure.
• Delivery reliability.

Incoterms should therefore be considered during supplier negotiations.

Incoterms and Sales Management

Export sales teams should understand Incoterms because customers frequently request particular delivery terms.

A sales representative who offers DDP without understanding the destination-country import requirements could create significant problems for the organization.

Sales teams should work with logistics, finance, tax, customs, and compliance professionals when necessary.

Incoterms and Finance

Finance departments need to understand Incoterms because they influence transaction costs and risk.

The finance team may need to consider:

• Freight costs.
• Insurance costs.
• Customs duties.
• Taxes.
• Payment timing.
• Cash-flow implications.
• Working capital.

A change in Incoterm can therefore affect financial forecasting.

Incoterms and Risk Transfer Example

Consider a shipment where the seller pays freight to the destination but risk transfers earlier.

If the goods are damaged during the international journey after risk has transferred, the buyer may bear the risk even though the seller paid the freight.

The buyer therefore needs to understand when risk transferred and whether appropriate insurance exists.

This is one of the most important practical lessons in Incoterms.

Incoterms and Contract Drafting

An Incoterm should be written clearly in the contract.

A strong contractual reference should identify the rule and the agreed location.

For example, the contract should avoid simply saying:

“Goods sold FOB.”

Instead, the parties should clearly specify the applicable rule, named port or location, and relevant version where appropriate.

Incoterms and Dispute Prevention

Clear Incoterms reduce misunderstandings.

When a shipment is delayed or damaged, the parties can refer to the agreed delivery rule to determine which responsibilities were allocated to each party.

However, disputes can still arise if the named place is unclear or if the parties misunderstand the rule.

Incoterms and Logistics Planning

Logistics planners should identify the selected Incoterm before arranging transportation.

They need to know:

Where are the goods collected? → Who books the carrier? → Who pays the freight? → Where does risk transfer? → Who arranges insurance? → Who handles export clearance? → Who handles import clearance? → Where are the goods delivered?

Answering these questions helps create a practical logistics plan.

Practical Incoterms Decision Process

A business can approach Incoterm selection using the following process:

Identify transport mode → Determine desired control → Identify delivery location → Allocate transportation responsibilities → Determine insurance needs → Allocate customs responsibilities → Assess risks → Calculate landed cost → Confirm legal and operational feasibility → Document the agreement

This approach helps ensure that the selected term matches the actual transaction.

Key Takeaways

• Incoterms are standardized international trade rules developed by the ICC to clarify certain buyer and seller responsibilities.
• Incoterms help define delivery obligations, transportation responsibilities, cost allocation, and risk transfer.
• Incoterms do not replace the sales contract and do not generally determine ownership or title.
• The current ICC edition is Incoterms 2020.
• The 11 Incoterms are divided between rules applicable to any mode of transport and rules designed specifically for sea and inland waterway transport.
• EXW places substantial responsibility on the buyer, while DDP places substantial responsibility on the seller.
• FCA, CPT, CIP, DAP, DPU, and DDP can generally be used for any mode or combination of modes of transport.
• FAS, FOB, CFR, and CIF are intended for sea and inland waterway transport.
• Under CPT and CIP, the seller pays carriage to the named destination, but risk transfers earlier when the goods are delivered to the carrier under the applicable rule.
• Under CFR and CIF, the seller pays freight to the destination port, but risk transfers when the goods are loaded on board the vessel at the port of shipment.
• CIP and CIF include seller insurance obligations, subject to the specific requirements of the applicable Incoterms rules.
• DAP requires the seller to deliver goods to the named destination ready for unloading.
• DPU requires the seller to deliver the goods at the named destination after unloading.
• DDP places extensive responsibilities on the seller, including import clearance and applicable import duties and taxes under the rule.
• Incoterms should not be used without clearly identifying the relevant named place.
• Transportation costs and risk transfer must be analyzed separately because the party paying transportation is not necessarily the party carrying the risk during the entire journey.
• Incoterms influence landed cost, logistics control, insurance arrangements, customs responsibilities, and supply-chain planning.
• The selected Incoterm should reflect the transportation mode, logistics capabilities, customs requirements, risk tolerance, insurance needs, and commercial objectives of both parties.
• For containerized shipments, FCA may often be more appropriate than FOB when delivery occurs to a carrier before the goods are loaded onto a vessel.
• Incoterms should be coordinated with payment terms, insurance arrangements, customs procedures, and other provisions of the sales contract.
• Effective use of Incoterms reduces ambiguity, improves logistics coordination, supports accurate pricing, and helps prevent international trade disputes.