The reason for logistics is to affect trade. No one would need logistics if there was no need to get goods to the end customer, and to do it efficiently and effectively. In other words, doing something with less, and doing the right thing. Together they add value to the customer as the right goods show up at the right time (effective) and at the right price (efficiency). Together these represent the 4 Ps of marketing — product, price, place and promotion — and contribute directly to the satisfaction of the customer. To achieve the goal of customer satisfaction via efficient and effective logistics requires a coordinated and planned capability. Every player in the logistics chain must have a clear understanding of the role and responsibilities they have to ensure success. And that leads us inexorably into the use of Incoterms, which give the buyer and seller their roles and responsibilities in the movement of the goods.
Incoterms are commercial terms that, properly utilized, provide precision in who does what and when in the logistics chain. The International Chamber of Commerce publishes these terms after extensive consultation, and currently they are revised every 10 years. They define the role and responsibility of the buyer and seller as to who must do which part of the physical move, who provides what documentation, and who is responsible for risk and the insurance to mitigate this risk. All this is done with the Incoterms three-letter trade term, followed by a place where the buyer and seller responsibilities transfer.
It sounds so simple, but the understanding of this is more than just picking an Incoterm that “kind of suits.” The choice of Incoterm has consequences. I have found that they are poorly understood, poorly used and in many cases abused.
The Importance of Incoterms
So, what is an Incoterm and why is it so important? Imagine if you are writing a legal document for the sale of your goods. The last thing you say is “any clause will do” if you are defining the terms and conditions for example. Yet many people treat Incoterms in this way. These terms are complex and must be fully understood before they are used, or there can be unintended consequences for the entities moving the goods, for the flow of communication and for the payments associated with the services and the goods.
Incoterms define the buyer’s and seller’s roles and responsibilities along the logistics chain. The point shifts where the role and responsibility moves from the seller to the buyer progressively along the logistics chain, and the point is defined by the first letter of the trade term:
E - Ex Works transfers the goods at the seller’s location (EXW)
F - means the seller has freight contract obligations in the country of the seller (FCA, FAS, FOB)
C - means the carriage is paid by the seller to move to another country (CPT, CIP, CFR, CIF)
D - means the goods are delivered by the seller into another country (DAT, DAP, DDP).
Four of these terms (FAS, FOB, CFR, CIP) are reserved for sea and inland waterway use.
The use of an Incoterm gives a large amount of commercial information to the buyer and seller. The Incoterms are underpinned by 10 subsets of legal definition of who does what and when, who pays for which portion, and who assumes what risk. These subsets include such topics for both the buyer and seller of:
Licenses, authorizations, security clearances and other formalities (includes Customs Clearance)
Contracts of carriage and insurance
Transfer of risks
Allocation of costs (who pays for what)
Notices to the parties (information flow)
Proof of delivery
Inspection, checking, packaging and marking
Assistance with information and related costs
And suddenly the realization is that the 3-letter Incoterm is a plethora of legal clauses dealing with the movement of the goods by the buyer and seller. These issues need to be understood in detail before an Incoterm is chosen, as each one involves legal obligations, costs and responsibilities.
The correct use of Incoterms is vitally important. First, the form of the Incoterm is often not correctly defined. The Incoterm is the three-letter trade term with the place where the buyer and seller responsibilities transition, followed by the statement that this is the Incoterms 2010 version. The more precise the place is specified, the better. For example FOB (Port of Houston) Incoterms 2010, could be any terminal in the port. This can be improved with FOB (Terminal X, Port of Houston) Incoterms 2010 or even FOB (Quay #Y, Terminal X, Port of Houston, Texas USA) Incoterms 2010!
So Much Complexity
As one can see this is becoming even more and more complicated.
So where do all the problems come from? The first problem is these are inserted into the Contract of Sale. These are generally negotiated by sales people, who have no understanding of the Incoterms and what impact they can and cannot have on the logistics chain. A logistics person should be present and part of this negotiation, but that is not common. The next major flaw is the belief that the Incoterm defines the transfer of title and the point where payment becomes due. The International Chamber of Commerce documents specifically state that this is not the case and Incoterms are not to be used for the transfer of title and the trigger of payment terms. Salespeople are often focused on getting paid and choose the Incoterm to suit the payment details. In many cases their wording, approved by legal, makes the logistics process so convoluted that the inefficiency and reduced effectiveness overshadow the early payment value. In every sales contract there should be an Incoterm, a separate title transfer clause which specifies the point and conditions which will allow title transfer, and a payment clause which defines what conditions must be met to allow payment. It must be understood that the payment trigger point, the title or ownership transfer and the Incoterm can be at completely different points in the logistics chain, and with different conditions.
In many companies the Incoterms were chosen in the dim and distant past. They have become perpetuated in legal contracts by legal personnel and contract negotiators without thought of today’s market and changes. I have seen contracts issued by large corporations which refer to Incoterms that disappeared in 2000, and have no real validity today. While that is unforgivable, it reflects the lack of understanding in the legal, sales and logistics departments to choose a competitive Incoterm.
There is also a unique issue in the U.S. Incoterm-like clauses are embedded in the U.S. Uniform Commercial Code (U.S. UCC). This was written originally in 1952, and last revised in 2004. Many states have not signed the 2004 version, so there are differences among states, where some use the older version and some use the newer version. The U.S. UCC (U.C.C. Article 2) uses some of the same three-letter trade terms as the ICC, but the definitions are very different. For example, FOB (Free on Board) in the U.S. UCC can be for “loaded on a truck” or even “delivered by a truck.” In the ICC version the FOB is only for vessels loading non-containerized cargo in a port. The ICC version is far more precise, removing ambiguity. The U.S. UCC three-letter trade terms cause confusion, and if this ever went to a court it would be a time-consuming and costly exercise of legal issues based on the state where the problem occurred. The use of anything other than the ICC versions will be legally imprecise, and subject to interpretation, which is anathema in a good contract.
It may not sound like an issue, but lack of precision in a logistics move can be full of problems which cost money and time, both of which affect efficiency and effectiveness. Take a practical example, where the vessel agent for unloading multiple items from a breakbulk vessel had a tally clerk (someone counting the specific items to be unloaded), the stevedores doing the unloading had one, and the warehouse or terminal had one. At the end of 36 hours of unloading, there was a discrepancy of count among all three! This has happened to me, and the ensuing accusations, threat of non-payment and sheer waste of time is unbelievable. Incoterms hold one party responsible for the count, and the marks and the documentation responsibilities are clear.
The Sea and Waterway rules appear to be very similar to the all-mode rules when one looks at the 3-letter trade term. For example, the CIF (Cost Insurance and Freight) would be similar to CIP (Carriage and Insurance Paid to) rule. So why not use the all-modes version of CIP? The problem is the law of the sea and waterways has different details embedded into the sub-clauses, and in many cases different legal interpretations than that of the normal land transport or air transport. The ICC version takes these into account and gives specific clauses that have legal precedent. The all-modes do not have this water movement embedded, so if it is a move by water, these four clauses unique to water movement must be used.
How to Choose the Incoterm
The choice of the Incoterm is a logical process. There are a number of factors that need to be balanced. If your company is astute in trade, then the more that you control the logistics, the greater the service given to the customer, the greater the profit. (And, of course, you can get a markup on the logistics costs as well.) On this logic you would want to control all the processes to the delivery point, and domestically that is correct. But if you are delivering to another country, pause for a moment and think about the payments. Do you have the capability to do the payments to service providers and customs in the other country? If you do, then you need to try and maximize the service under your control to the customer. If you cannot do these payments simply, then your Incoterm needs to stop before the D terms and use a C term.
The next issue is insurance. If your logistics capability is really good, you might well self-insure the goods. Remember, Incoterms are about buyer and seller responsibilities, so other insurances are needed for personal and third-party liability and catastrophes. The decision to self-insure is done, presumably, because your costs are less than carrying external insurance, so you can make a little profit off this if you include the full cost of insurance in your logistics costs with self-insurance.
Incoterms are simply essential for any sales contract. They must be chosen to maximize profit, and to comply with the skills and knowledge of your company. They should not be negotiated by anyone other than a knowledgeable logistics professional so the cost and time consumed by logistics is minimized. Separate clauses for title or ownership transfer and for payment trigger points must be present, as these are not part of the Incoterm.
Incoterms are not simple, and badly used they can cost time, money and result in unhappy customers. Used well, with knowledge and understanding, they can expedite logistics and support the “place” aspect of marketing, enhancing customer satisfaction! And above all, these need knowledge, experience and understanding of logistics costs and processes to choose wisely.
John Vogt is a visiting assistant professor at University of Houston-Downtown and president of WWBC Consultants.
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