Which Incoterm is Best for You?

There are 11 to choose from, but which is the best for your situation…for your company?

LWL029 Alphabet Soup

Let’s first review the basics of incoterms.

Incoterms or International Commercial Terms are a series of pre-defined commercial terms published by the International Chamber of Commerce (ICC) that are widely used in International commercial transactions or procurement processes.

Some things to remember about incoterms:

  • Incoterms are critical in order to determine the point at which risk of loss or damage to the goods transfers from the seller to the buyer.
  • Incoterms are critical to determine which party has responsibility for transportation, transportation insurance, import duties, import taxes and other related expenses.
  • Incoterms do not consider transfer of title.
  • Contracts require an incoterm that includes the location (city, state/province, country). For example: “DAP Milan, Italy”

While there are various factors to consider when choosing the “proper” incoterm for your company and for your given situation, the “incoterm continuum” shown below provides a quick overview of which party (buyer or seller) has the most and least responsibility regarding transportation costs, insurance costs, import duties and the management of the shipment to the final destination.

LWL029 Incoterm Continuum

Specifically, here are some areas to consider when choosing the appropriate incoterm:

Bargaining Position
Companies may want to put the burden of delivery (at any cost) on the seller; for instance, a buyer may want a long-distance seller of cargo to have DAP terms in case there is a need for “expedite” transportation; in such cases, the expedite costs would fall to the seller, if they did not meet the delivery date. We have seen this in cases of very heavy material where the air freight costs (in the case of an expedite) would be very expensive.

Freight Purchasing Power
Which side (buyer or seller) can obtain the lowest transportation cost? That company would take on the responsibility for the freight cost in order to keep total costs at a minimum.

For instance, if the seller is a large multinational company with great transportation rates, then perhaps it’s best that the seller provide carriage to your required destination. On the other hand, if the buyer wants to consolidate various shipments from the same origin region, then the buyer may want EXW or FOB terms.

The point is: understand which party has the superior buying transportation power and be sure that that party controls the main carriage.

Revenue Recognition
When does your company want to recognize the revenue: on the seller’s side or the buyer’s side?

The terms EXW, FOB, FCA, FAS, CFR, CIF and CPT are all shipment contracts. The seller delivers by handing over the contract goods to a carrier somewhere on the seller’s side. Depending on the terms, the place could be the seller’s premises, a carrier’s terminal, a forwarder’s warehouse, or alongside or on board a ship. In these cases, the seller recognizes the revenue on “their” side.

The “C” terms (CFR, CIF, CPT) are the most seller friendly, as they allow the sellers to choose the carrier and forwarder. They are accompanied by places on the buyer’s side as the seller pays for main carriage.

Unfortunately, senior management and accountants often take this to imply destination contracts and mistakenly prohibit their use in the name of prompt revenue recognition.

The terms DAT, DAP and DDP are destination contract terms as the seller delivers somewhere on the buyer’s side. Delivery on the buyer’s side means deferred revenue recognition.

Degree of Control
If the buyer wants to better control deliveries to its plants (using a JIT strategy), then the buyer may want full control, so the buyer would lean towards the EXW term.

In fact, Devendra Bharambe, deputy general manager for demand chain management at Mahindra & Mahindra recently advised, “the use of ex-works enables cost savings by eliminating the value added by the tier supplier for shipping.”1

So, this strategy can help your company obtain better transparency into your total costs across the supply chain.

Legal and Financial Restrictions
Some country regulations may demand that the buyer pays the freight and insurance within their own country.

Destination Country’s Infrastructure and Traditions
It may be risky for the seller to offer terms of delivery up to the buyer’s location, if there are many risks involved with transport within the buyer’s country. These risks could be equipment shortage (of trucks or container chassis), risk of strikes within that country or even corruption. If the seller cannot deliver the product up to the buyer, then the seller may be liable for costs outside of their control. For instance, importing into Russia and transporting across country.

Company Policy
Companies may want to standardize all contracts with one incoterm to avoid confusion and maintain consistency.

Value of the Goods Shipped
Low value products (iron ore, coal, etc.) may not require additional insurance coverage as per CIF or CIP.

Hopefully, this provided you with some direction on choosing the most beneficial incoterm for you.

Find the right place to transition from seller to buyer.
LWL029 Baton Handoff

If you have any additional insights, please let us know!

You can order a copies of Incoterms 2010 by the International Chamber of Commerce at
http://store.iccwbo.org/incoterms-2010.

Good luck!

Click the following link for a PRINTER FRIENDLY VERSION of this article:LWL029 Which Incoterm is Best for You

 

Sources:

1: http://automotivelogistics.media/magazines/automotive-logistics
January/March 2017 Edition, page 20.

About Lenny

Many years of experience in a Fortune 1000 companies, especially in the logistics and I.T. areas of manufacturing companies. Through process improvements and the use of many of the tools mentioned here, I have been able to identify and implement savings opportunities worth up to $10 million. I hope that some of these real-life stories, suggestions and tools can help you!
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