Imagine you buy 1,000 designer lamps from a manufacturer in Italy. A month later, you get a call from the shipping port saying your lamps won’t be released until you pay $3,000 in ‘terminal handling fees’ and customs duties. Incoterms explained
This is exactly why Incoterms exist.
Incoterms (International Commercial Terms) are the universal language of global trade. They are published by the International Chamber of Commerce (ICC) and updated periodically to reflect changes in global shipping practices.
These three-letter codes tell both the buyer and the seller exactly who is responsible for what. Without them, international shipping would be a never-ending argument over who pays the bill and who is to blame if a crate falls into the ocean.
The Three Pillars of Every Incoterm
Before we look at the specific codes, you need to understand that every Incoterm answers three basic questions:
- Costs: Who pays for the truck, the ship, the insurance, and the taxes?
- Risk: At what exact point does the “safety” of the goods move from the seller to the buyer? (If the ship sinks, who loses the money?)
- Responsibility: Who handles the necessary tasks, like export licenses, customs paperwork, and port security fees?
Common Incoterms: Real-World Examples
There are 11 different Incoterms, but you will likely only use some of them. Let’s understand them using real shipping scenarios.
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EXW (Ex Works)
This is the most basic term. The seller’s only job is to make the goods available at their own factory or warehouse.
For instance, you buy 500 handmade chairs from a factory in Vietnam. The factory owner calls you and says, “The chairs are on my loading dock. Come get them.”
Then, you have to hire a truck in Vietnam, handle the Vietnamese customs paperwork, find a ship, and pay for everything until the chairs reach your door. This is very risky for beginners because you are responsible for everything in a country where you might not know the rules.
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FOB (Free on Board)
FOB is the “gold standard” for sea shipping. It creates a fair split between the buyer and the seller.
Consider this example, you are importing electronics from a supplier in Shanghai. The seller pays to get the electronics onto a truck, through Chinese customs, and physically onto the ship.
The risk moves from the seller to you the moment the goods are “on board” the ship. Once the crane drops that container onto the deck, it’s yours. You pay for the ocean freight and the delivery to your warehouse.
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DDP (Delivered Duty Paid)
DDP is the “Amazon Prime” of the shipping world. It is the easiest option for the buyer but the most expensive.
To illustrate, you order high-end wine from a vineyard in France for your boutique shop. The French vineyard handles everything. They pay for the truck in France, the air freight, the US customs duties, and the final delivery truck to your shop.
You just sit back and wait for the delivery. However, the seller will build all those costs (plus a little extra for their trouble) into the price of the wine.
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CIF (Cost, Insurance, and Freight)
This is similar to FOB, but the seller takes on a bit more of the cost to make the buyer feel safer.
Let’s examine a simple example, you are buying raw coffee beans from Brazil. The seller pays to get the beans on the ship (like FOB), but they also pay for the ocean freight and a basic insurance policy.
Even though the seller pays for the freight, the risk still transfers to you the moment the beans are on the ship. If something happens at sea, you are the one who has to file the insurance claim, not the seller.
How to Choose the Right Incoterm for Your Business
If you choose the wrong term, it can significantly impact your profit margins. Here’s a brief guide to help you choose wisely.
- If you are a total beginner: Start with DDP. It’s more expensive, but it prevents you from getting hit with “surprise” customs fees that you didn’t see coming.
- If you want the best value: Use FOB. It allows you to choose your own shipping company (freight forwarder). Because you control the shipping, you can often find better rates than the seller would give you.
- If you are buying from a trusted, massive supplier: FCA (Free Carrier) is a great choice. It’s flexible and works for air, sea, or truck.
Critical Mistakes to Avoid
Even if you know the codes, it is easy to make these three common mistakes:
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Being Vague About the Location
Never just write “FOB China” on a contract. China is huge. If your supplier is in Ningbo, write “FOB Port of Ningbo, Incoterms 2020.” Being specific prevents the seller from choosing a cheaper, further-away port and charging you for the extra trucking.
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Forgetting About Insurance
Only two Incoterms (CIF and CIP) require the seller to buy insurance. For all others, it’s up to you. If you are shipping $50,000 worth of goods, spending $100 on cargo insurance is the smartest move you’ll ever make.
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Ignoring “Hidden” Port Fees
If you use a term like DAP (Delivered at Place), the seller pays for the shipping to your city, but you are responsible for unloading the truck and paying customs. Many importers forget this and get hit with “Demurrage” fees (basically “parking tickets” for containers) because they didn’t clear customs fast enough.
A Reminder
Always ensure that your contract specifies which version of the rules you are using. The latest version is Incoterms 2020. While older versions (like 2010) are still legal, but the newest version provides the most up-to-date protections.
Note: If a supplier won’t budge on the price of the goods, try asking them to change the Incoterm from FOB to CIF. You might save thousands of dollars on shipping costs instead.
A Gentle Suggestion
Before you sign a contract with a new international supplier, call a freight forwarder. Show them the quote and the Incoterm. They can quickly tell if there are hidden costs you’ve missed. It’s much better to find out about a $2,000 fee now than when your goods are sitting at the dock.
At Landing Cargo, we work with importers and exporters every day to simplify global shipping and eliminate hidden costs.
FAQs
What are Incoterms in simple words?
Incoterms are rules that explain who pays for shipping, who handles paperwork, and when the risk transfers from seller to buyer. They prevent confusion in international trade.
Which Incoterm is safest for beginners?
DDP is usually the safest for beginners. The seller handles shipping, customs, and duties. You pay more, but you avoid surprise costs.
Does FOB include shipping costs?
No. Under FOB, the seller pays until the goods are loaded onto the ship. After that, you pay for ocean freight, insurance, and delivery.
Do all Incoterms include insurance?
No. Only CIF and CIP require the seller to arrange insurance. For all other terms, you must decide whether to buy cargo insurance yourself.
What happens if I don’t specify the Incoterms version?
It can create confusion. Different versions (like 2010 vs. 2020) have small rule changes. Always write something like “FOB Shanghai, Incoterms 2020” in your contract.
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