When you’re new to the world of shipping, the terminology can feel overwhelming. Experienced shippers, buyers, and sellers may even sound like they’re speaking a foreign language.
One set of terms that causes considerable confusion are Incoterms®. This set of rules, created by the International Chamber of Commerce (ICC), defines the responsibilities of buyers and sellers around the delivery of goods. The ICC updates this set of rules every ten years, with the most recent update—the aptly named Incoterms 2020 rules—released in 2020.
The Incoterms rules form a crucial part of any agreement between buyers and sellers by dictating who will pay for loading and unloading costs, customs export procedures, insurance, import costs, and more. By understanding the Incoterm rule defined in a contract, buyers and sellers can get a firm grasp on their costs and, ultimately, their margins. However, without this understanding, one party may end up footing the bill for more than they bargained for.
In this article, we’ll get you up to speed on Incoterms—what they are, what they mean, what to look for, and what to avoid. We’ll also give you a detailed walkthrough of the five most common Incoterms rules. Armed with this information, you’ll both be able to speak the secret language of shippers and sellers and become a savvy negotiator who knows how to protect your bottom line.
What Are Incoterms?
Incoterms are a set of rules established by the ICC to establish who’s responsible for shipping, insurance, and tariffs in a contract between a buyer and a seller.
In the simplest terms, Incoterms can reduce confusion between buyers and sellers. By defining eleven different costs in a three-letter designation, the Incoterms rules quickly define who will pay for what.
Note: Even though the Incoterms rules were updated in 2020, some parties may still use the Incoterms 2010 rules. (Or an earlier version!) Make sure that both parties to your contract are working from the same version when entering into a contract.
You can see a full run-down of all eleven Incoterms in the following chart:
[Download This Chart as a PDF]
Here’s how these Incoterms come into play: As a buyer defining your agreement with your seller, you’ll negotiate two elements:
- The three-letter Incoterms designation, which you can decode with the chart above.
- The named place for the final destination, which ensures delivery to a location where you can access your freight, either to pick them up or arrange for further transport. (Note: It’s important to get very specific, especially in cities with multiple ports. Otherwise, you may spend a day chasing your delivery around.)
Before signing any contracts, make sure to review both of these elements carefully. If you make a mistake—or agree to terms that you’re not comfortable with—you could end up paying a lot more than you’d budgeted for. You’ll understand why as we dive into the five most common Incoterms you’ll encounter.
What Changed from 2010 to 2020?
The ICC updates the Incoterms rules every ten years. The most recent update, in 2020, included six key changes. In brief, these included:
This change offers buyers more flexibility in terms of delivery location.
This insertion reduced a significant risk to sellers in a very specific case—when letters of credit were used as payment.
Under the 2020 rules, the seller must purchase more complete coverage as defined by Clause A of the Institute Cargo Clauses.
Whereas previous Incoterms implied that sellers would use third-party delivery services, the ICC added explicit language allowing sellers to also use their own transportation methods to move goods.
The new version of the Incoterms rules offers new clarity to avoid any confusion.
To make the rules even easier to use, the ICC reordered the terms and added additional notes for clarity.
Who Is the ICC?
At this point, you might also be wondering who the ICC is—and why they’re the organization responsible for these standardized rules. The ICC is the largest business organization in the world, which represents more than 45 million member companies in more than 100 companies.
The ICC was founded after World War I, at a time when there was no global system of rules to govern trade or commercial relations. The organization was built around the belief that the private sector, rather than government, is best qualified to set global business standards. Today, their mission is to promote international trade and investment as vehicles for inclusive growth and prosperity.
Decoding the 5 Most Common Incoterms
Understanding the established Incoterms rules has become more important than ever. Many new players are shipping and receiving goods, due in part to the continued expansion of the Amazon marketplace. The Incoterms rules offer buyers and sellers a common language so there are fewer surprises and misunderstandings.
Although the full 2020 Incoterms rules define eleven different scenarios, we’ll cover the five most common ones you’ll see:
Budgeting for Your Bottom Line
Now that you understand the most common Incoterms, you may have noticed that the terms can leave your final cost up in the air. In fact, with the exception of DDP, you’ll have to take additional transportation and import costs into account before you can determine the final cost of the goods you’ve purchased.
Need assistance calculating that number? Talk to an experienced freight forwarder. In addition to arranging for transportation in other countries, a forwarder can help you estimate costs, arrange for the correct import/export paperwork, pay duties on your behalf, and expedite the shipping process. They can also walk you through the right Incoterms for your particular situation so you can negotiate more effectively with your suppliers.
As you’re adding up your final cost, there’s one additional number you might want to take into account when you’re budgeting: insurance. Two 2020 Incoterms rules require that the seller pay for insurance:
- Under the CIF Incoterm, minimum coverage is required, as defined by Clause C of the Institute Cargo Clauses.
- CIP, on the other hand, requires more complete coverage, as defined by Clause A of the Institute Cargo Clauses.
Additionally, under the DAP, DPU, and DDP Incoterms, the seller is liable for any damage to the shipment up to the door of its destination. However, the seller is not obligated to purchase insurance to cover any losses. Instead, they can choose to pay out of pocket to resolve the situation to both parties’ satisfaction.
If you’re working under an Incoterm rule that includes insurance, make sure you understand the specifics of the coverage. If you need to arrange for insurance, your freight forwarder can assist.
Understanding Incoterms to Negotiate with Confidence
With a strong understanding of the Incoterms rules, you’ll find it easy to speak the language of international commerce. Those terms that once sounded like gibberish will become familiar, and your confidence in navigating your contracts will grow. Most importantly, with a strong understanding of the Incoterms in your agreements, you’ll be positioned to negotiate the best deal for your business and its bottom line.
Need some help estimating shipping costs, duties, and more? As a freight forwarder with almost 30 years in the business, we’re well-equipped to answer any questions you have. Simply reach out to us and we’ll help you price out your next shipment from origin to destination.
Get a Free Quote