What are Incoterms and why are they so important in global logistics?

Bob called and asked what kind of coffee I prefer – he wanted to see me and seemed to have an urgent question. “Now that I am responsible for our supply chain I really want to understand it all. So I went through our shipping documents of the recent months and noticed inconsistencies. Some commercial invoices and bills of lading show ‘Incoterms: EXW’, others read a three-letter code, such as ‘DAP’ without the word Incoterms. And I found documents without any of it. What does this all mean?”

Most important in international shipping, and rarely fully understood by exporters and importers, are Incoterms. Incoterms are internationally recognized rules. They define the responsibilities of the shipper and the consignee in an export/import transaction. More specifically, Incoterms clearly point out how and where the risks and costs for an international transportation move are transferred between the shipper and the consignee. 

“So in the sales agreement with our overseas vendors, we should define under what terms the freight moves, yes?”, Bob prompted. 

Yes, Incoterms for a shipment should match the sales contract between the seller and the buyer. If the sales contract determines the seller is responsible to pay for the international transportation (airfreight or ocean freight), we speak about Prepaid Freight at origin. If the buyer is responsible for the international freight portion of the shipment, it is referred to as Collect Freight, which is paid for at destination upon port arrival. 

  “And what are the differences between the terms I found: EXW and DAP? What do Incoterms tell me about who pays for transportation?”

DAP is an example for a prepaid term. It was the seller’s responsibility to arrange transportation to a named place. Often the named place in DAP shipments is the buyer’s (dock) door. 

EXW is a collect term. EXW means that after the shipper loaded the cargo onto the pickup vehicle, the cost and risk for transportation transferred to Bob’s company.  

Bob concluded: “So DAP and EXW aren't just different ways of writing the shipping terms. They actually tell me who is responsible for the transportation and where that responsibility changes!” 

“But if the supplier pays the freight under DAP, am I not still paying for it somehow?”

Exactly. The buyer ultimately pays for transportation one way or another. When the seller includes freight in the product price, however, the actual transportation cost may no longer be visible to the buyer. 

Bob paused. “So if I control the freight, I can actually see what I'm paying for transportation and manage that cost separately.”

Incoterms also define when the risk transfers from seller to buyer. That can determine who is responsible when something goes wrong and has implications for cargo insurance.