Commentary: Avoiding Incoterm misuse

   Contemporary anecdotal evidence suggests, and recent empirical substantiation supports, the phenomenon that shippers are continually misusing Incoterms. This practice continues among the world’s shippers despite the International Chamber of Commerce’s insistence that certain terms are solely intended for maritime or intermodal containerized freight. But the fault may not lie solely on the buyers and sellers or their designated freight forwarders. International banking institutions often fail to update their respective letters of credit applications to reflect the new Incoterms, forcing shippers to use outdated terms in order to comply with the law vis-à-vis documentation and payment requirements on letters of credit (LC) transactions.
   Our recent empirical investigation (presented in the Journal of Transportation Management 2014, and Journal of Transportation Law, Logistics, and Policy 2014) sheds light on why shippers misuse maritime terms most frequently, and how international banking institutions are partly culpable in perpetuating this misuse by failing to update their procedures.
   Incoterms 2010 outlines on a mutually exclusive basis, the rights, duties, obligations, and responsibilities of both buyers and sellers in the discharge of their respective transportation obligations. Each term varies from the others, and shippers should understand how each differs in an effort to maximize its performance and minimize disruptions and disputes.  
   Incoterms 2010 took effect on Jan. 1, 2011, and reduced the number of terms from 13 to 11; classified into two groups from four, specifically to guide shippers toward using the appropriate terms. The new Incoterms, or rules, are separated as follows: 1) Rules for use in relation to any mode or modes of transport, which can be used where there is no maritime transport at all, or for transportation transactions in which maritime transport is used for only part of the carriage (i.e., intermodal maritime); and 2) Rules for ocean and inland waterway transport, where the point of dispatch and delivery are both ports. Thus, FAS (Free Alongside Ship), FOB (Free On Board), CFR (Cost and Freight paid), and CIF (Cost, Insurance, Freight paid) belong to the latter class of rules; while EXW (Ex-Works), FCA (Free Carrier), CPT (Carriage Paid To), CIP (Carriage, Insurance Paid to), DAP (Delivered At buyer’s named Place), DAT (Delivered At buyer’s named Terminal), and DDP (Delivery Duty Paid) belong to the former.
   Among our critical findings:

• FOB continues to be misused, especially for intermodal containerized freight, despite the ICC’s warning that FOB is inappropriate for such movements.
• FOB use by an inland producer of manufactured goods leads to a “risk gap” as the critical point—the delivery point where risk transfers has not been crossed until the container is on board the ship.
• EXW is becoming more popular for some large shippers in an effort to retain supply chain “visibility.” Firms such as Walmart and John Deere prefer EXW because it allows the buyer to keep an eye on the goods from the seller’s door to the buyer’s dock.
• Many shippers remain ignorant of the ocean carrier’s liability if their container is damaged or lost at sea.  It is $500 per “package” under the Carriage of Goods by Sea Act (COGSA). Therefore, if a shipper uses a term placing the risk on itself, then the shipper must obtain proper cargo insurance.
• Letters of credit and bank guarantees often require significantly different and conflicting duties of shippers.
• Hidden “fees” and surcharges have proliferated and Incoterms are sometimes deliberately misused in certain countries to manipulate or game the system. For example, CFR can be used to conceal kickbacks from shippers.

Suggestions:

• Ensure your international banks, whether acting as the “confirming” or “advising” bank, or the “issuing” bank on an LC transaction, are using documentation that correctly conforms to the Incoterm being applied.
• Ensure every contract of sale includes a transportation term, as Incoterms are not law in and of themselves, but become legally binding only when written into the contract of sale.
• FCA is the appropriate “F” term for multimodal transit. The erroneous use of FOB exposes sellers to a “risk gap” as many shippers believe that once a container is in the hand of the carrier the risk has transferred. It has not under FOB until the container is on board the ship. Accidents happen on the way to the ship.
• Consider using EXW to maximize supply chain visibility when necessary. For example, in China, large shippers can consolidate purchases using FCA to move partial shipments to a centralized location for shipment abroad, thereby controlling every step of the process.

   Correctly using Incoterms and ensuring banking practices and documentation are congruent with your transportation strategies will help to maximize your supply chain performance.

Drew Stapleton and Vivek Pande
University of Wisconsin
La Crosse, Wis.

Dennis O’Brien 
CEO, APC Logistics Pty Ltd., 
Port Melbourne, Australia

This commentary was published in the November 2014 issue of American Shipper.