One set of terms that causes considerable confusion are Incoterms. This set of rules defines the responsibilities of buyers and sellers around the delivery of goods.

In other words, the Incoterms rules form a crucial part of your buying agreement with a seller by dictating who will pay for loading and unloading costs, customs export procedures, insurance, import costs and more.

When you understand the Incoterms in your contract, you’ll have a grasp on the final cost of the product you’re importing. However, without this understanding, you may end up footing the bill for more than you 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. Armed with this information, you’ll both be able to speak the secret language of shippers and sellers and you’ll become a savvy negotiator who knows how to protect your bottom line.

What Are Incoterms?

Incoterms are a set of rules established by the International Chamber of Commerce (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 establish who will pay for what.

Note: The Incoterms rules have been updated several times, with the most recent revision in 2010. Some companies may still use the Incoterms 2000 rules, so make sure that you and your seller are both working from the same version when entering into a contract.

To understand the eleven costs that Incoterms define, take a look at the following chart:

[Download This Chart as a PDF]

Here’s how these Incoterms come into play: When defining your agreement with your seller, you’ll negotiate two elements:

1. The three-letter Incoterms designation, which you can decode with the chart above.
2. The named place for the final destination, which ensures delivery to a location where you can access them, 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 package 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.

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 2010 Incoterms rules define eleven different scenarios, we’ll cover the five most common terms you’ll see:

1. EXW (Ex Works) – Under this Incoterm, you’re responsible for everything—picking up the item at the seller’s warehouse all the way through delivering it to the place where you need it. Although this may be the cheapest option up front, at the end of the day, it may end up costing you more. Why? Consider the fact that you’d probably have to pay for a dedicated delivery to port for your single order when the supplier might make multiple, consolidated deliveries each day that they’d probably charge you less for.

2. DDP (Delivered Duty Paid) – This is the polar opposite of EXW, in which the seller agrees to take care of all the costs in getting the goods to the location of the buyer’s choosing, including paying any duties involved. This is probably your most expensive option, but it’s the one that involves the least amount of logistics and coordination on your part.

3. FOB (Free on Board) – This Incoterm dictates that the seller will deliver the goods to a ship of the buyer’s choosing and pay for it to get loaded onboard. The buyer then pays for everything from there, including transport by ship. This may end up being your most cost-effective option, depending on the price you negotiate with your freight forwarder. Note that this is one of 4 Incoterms that only applies to sea/inland waterway transport.

4. CIF (Cost, Insurance and Freight) – This is also another Incoterm that only applies to sea/inland waterway transport. Like FOB, the seller will deliver the goods to the vessel and get it loaded on board. However, in addition to the requirements of FOB, the seller will also pay the ocean freight as well as the insurance. Once the vessel arrives in port, the buyer is responsible for the costs, including the unloading of the goods from the ship. You’ll see this Incoterm used frequently in both B2B and B2C transactions.

5. FAS (Free Alongside Ship) – Under this Incoterm, which only applies to sea/inland waterway transport, the seller is responsible for transporting goods to the named port on their end. However, once the goods are at the port, it’s the buyer’s responsibility to take it from there, paying for the goods to get loaded on the ship, the ocean freight and everything else needed to get the shipment to its destination.

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 help calculating that number? Talk to an experienced freight forwarder. In addition to helping you arrange transport needs in other countries, they can help you estimate costs, arrange for the correct import/export paperwork, pay duties on your behalf and help smooth 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. Although five of the eleven Incoterms include insurance paid by the seller, he or she is only required to provide minimum coverage. 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 additional insurance, your freight forwarder can also assist you.

Understanding Incoterms to Negotiate with Confidence

With a strong understanding of the 2010 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.