For both buyers and sellers, the transportation of goods for international trade naturally involves costs, but also risks, which are shared by each party to the contract in varying proportions. This is why Incoterms were created : it is a kind of insurance that aims to protect buyers and sellers during transport links and transfers of goods. This tool was created by the International Chamber of Commerce and is the contraction of the English words International, Commercial and Terms (IN-CO-TERMS). In short, Incoterms designate a contract, signed between different parties (buyers and sellers), in the framework of commercial exchanges.
In this article, we come back to two incoterms applicable exclusively to maritime transport: FOB and CFR.
What is an incoterm?
When a buyer decides to purchase a commodity, a whole logistics system is put in place. Incoterms are a very useful tool in the field of transport, allowing them to easily solve conflicts or litigations if there are any within the framework of the management of the goods and transport. But above all, their purpose is to determine the risks, responsibilities and formalities incumbent on each party.
Incoterms are re-evaluated every ten years by the International Chamber of Commerce in order to adapt to the conditions of international trade and transport.
Since 2011, there are eleven incoterms recognizable by their three-letter code, to be chosen by companies depending on their situation. These incoterms are categorized into two different groups: Incoterms Sea or Inland Waterway Transport and Incoterms Multimodal Transport.
Moreover, a revision of the Incoterms in 2020 has been established in order to reorganize them.
In the first group, the letters of the incoterms are FOB, FAS, CFR, CIF, and in the second: CPT, DAP, DDP, DPU, FCA, EXW. Incoterms are a non-mandatory tool, but highly recommended since 2020.
They are used by nearly 90% of international operations and they are specific to each company and to each situation.
It is also necessary to specify on the contract, the destination of the goods, because the incoterm is not enough, therefore it is essential to specify the place where the delivery will take place.
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What are the functions of the incoterm?
Incoterms have three main functions : primary, secondary and tertiary. They are used to govern the rights and duties of each party in an established contract related to international trade and transport.
These Incoterms define the legal obligations related to sales contracts, delivery and discharge of goods, payments, etc.
They allow to support what has been agreed upon in the original contract in case of a dispute. Incoterms have several functions and among them are :
- Cost risk assessment for both the seller and the buyer in the context of trade
- The division of responsibilities between buyers and sellers. Who is responsible for insurance? Transportation? Who is responsible for providing the legal documents?
- Cost allocation. Who manages the transportation and insurance costs?
- The distribution of risks. What are the risks associated with the transfer of goods? Who assumes them?
Some of these incoterms, especially those beginning with an E, define the buyer as the main actor in the process: he takes care of everything and the seller is only there to put the goods at his disposal.
Incoterms beginning with a D on the other hand, define the seller as the responsible party. He takes care of paying for everything and the buyer is not concerned about the costs.
The different Incoterms-2020
There are two main families of incoterms: those dedicated exclusively to sea transport and those dedicated to all modes of goods transport.
Incoterms-2020 Maritime/Inland Waterway Transport :
- FAS : Free Alongside Ship
- FOB : Free On Board
- CFR : Cost and Freight
- CIF : Cost, Insurance and Freight
Incoterms Multimodal Transport (for all transport used in logistics) :
- EXW : ExWorks
- FCA : Free Carrier
- CPT : Carriage Paid To
- CIP : Carriage ans Insurance Paid to
- DAP : Delivered at Place
- DPU : Delivered at Place Unloaded
- DDP : Delivered Duty Paid
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Focus on the FOB incoterm
The FOB incoterm implies that the seller is responsible for the goods until they are on board the vessel that serves as the primary mode of transport. Thus, the seller is responsible for :
- Packing of the goods
- Their transportation from the factory to the agreed port of shipment
- Their loading on board the ship chosen by the buyer
In addition, the clearance of goods for export is the responsibility of the seller and the seller is responsible for the costs and taxes associated with the export.
From the moment the goods are loaded on the ship, costs and risks are transferred to the buyer. It is his responsibility to pay the sea freight and any insurance to cover the damage. The buyer is also responsible for the customs formalities at import.
Focus on the CFR incoterm
Like the CPT Incoterm, the CFR Incoterm separates the transfer of risks from the transfer of costs. Thus, the seller assumes the cost of transport to the place of destination; he is, therefore, responsible for packing the goods, pre-carriage to the port of shipment and loading on board the vessel.
On the other hand, he is no longer responsible for the goods once they are loaded on board the vessel chosen by the buyer.
The risks are therefore transferred from the seller to the buyer when the goods are handed over to the carrier.
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The main differences between Incoterm FOB and Incoterm CFR
Both incoterms apply to ocean transport, but they provide for a different sharing of the costs and risks associated with the shipment of goods. Thus:
When a commodity is purchased FOB, it implies that the buyer must provide for payment of the main transportation and insurance costs. FOB Incoterms are the most widely used in international trade. However, the seller must pay attention to the cost of securing the cargo.
When a commodity is purchased at CFR prices, the buyer only pays for the insurance during the ocean transport, as well as the carriage of the cargo from the port of destination to its final place of delivery.
How to calculate an incoterm?
Incoterms have different cost depending on their classification. There are several methods and criteria on which to base the calculation of incoterms. The main criteria to take into account are: the commercial margin, the quantity of goods, the cost price of the goods, the price of packaging, and the cost of labor.
The calculation of incoterms is defined on the basis of these criteria and aims to determine the fair price of a commodity and its selling price for export.
Incoterms have become an indispensable tool in international trade, especially when a contract of carriage links a buyer and a seller.
Understanding their interest and knowing how to use them correctly allows to avoid any dispute or conflict between the parties involved in the same contract, or to know how to settle them. Incoterms thus help to properly carry out international transfers of goods.
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Importance of these incoterms for the logistics manager
For both import and export, the choice of incoterms is crucial to secure a commercial transaction. This is why every logistics manager must know and master them. Indeed, each of them provides for risk and cost transfer locations that have an impact on the cost, speed, and efficiency of shipments.
The more control you have over the freight, the higher the price of the shipment may be, but you are subject to fewer contingencies.
In any case, incoterms allow to settle any dispute that could arise between supplier and customer since the responsibilities and obligations of each are clearly defined. If they are not mandatory, incoterms are essential tools to optimize and secure the supply chain.
FAQ | FOB (free on board) Vs CFR (cost and freight): Incoterms explained
What are the advantages of incoterms?
Easy-to-understand terms, International standardization and Updated and clarified by an international body (ICC)
What are the disadvantages of incoterms?
Differences between buyer and seller preferences in the choice of terms and some clauses expose a party to excessive costs
What are the changes in Incoterms: 2020 vs 2010
DAT has become DPU: Delivered at Terminal has been replaced by Delivered at Place Unloaded. This is because goods can not only be delivered to a terminal or dock, but also to another location, such as a factory or warehouse. The bill of lading (BL) has been added to the FCA: it can be specified in the sales contract that a bill of lading must be issued. The bill of lading indicates that goods have been loaded on board. The buyer instructs the carrier to deliver this bill of lading to the seller. CIF and CIP contain different levels of insurance coverage: with CIP, the seller is obliged to take out full transport insurance. With CIF, there is an insurance obligation with a minimum coverage. FCA, DAP, DPU and DPP option for own means of transport: for these Incoterms, it is possible to organize the transport of goods with own means of transport.
Is the use of Incoterms voluntary or mandatory?
Some people mistakenly believe that Incoterms are mandatory or required by law. They are not. That said, it is strongly recommended that they be used in contracts for the sale of goods to avoid any ambiguity.
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