Introduction
It can be challenging for entities in an international trade transaction to agree on the delivery conditions, the party responsible for the goods while in transit, and the mitigation of unforeseen risks. Thus, adopting Incoterms, which refer to clusters of standardized regulations in international sales contracts, can be helpful in mitigating these issues (Davis & Vogt, 2022).
The International Chamber of Commerce (ICC) is charged with publishing Incoterms, which are then applied in international trade. The most recent version of these contract terms, Incoterms 2020, provides a comprehensive explanation of both parties’ obligations in international transactions. A breakdown of the importance of incoterms in an agreement, their merits and demerits, and the relevant criteria to use when selecting a particular incoterms form the basis of this paper.
Value of Incoterms in an Agreement
Clarifying Confusing Aspects to Minimize Conflicts
The entities participating in an international trade agreement enjoy different advantages when using Incoterms. Firstly, incoterms clarify confusing aspects, thus minimizing conflicts between transacting parties. This is because the delivery, insurance, and transportation obligations of both the buyer and the seller are stipulated in the Incoterms (International Chamber of Commerce, 2020). By being explicit about the conditions of the transaction, the parties can avoid disagreements and potential lawsuits.
Ensuring Awareness of Rights and Responsibilities
Secondly, incoterms ensure that both parties are aware of their rights and responsibilities by establishing a shared understanding of the terms and conditions of the agreement. This aids in streamlining the procedures of international transactions. Incoterms offer a consistent template for determining the transaction’s cost, which can expedite the process of bargaining and closing the sale. This can result in improved efficiency and friendly transaction fees. Furthermore, incoterms are a foundation for determining the cost of shipping, insurance, and duties for a particular transaction. They help both parties to define the moment at which liability for the items shifts from the vendor to the purchaser.
Reducing the Risk of Damage or Financial Loss During Transit
Thirdly, incoterms reduce the possibility of damage or financial loss to goods during transit. They ensure that each entity takes ownership of the goods at the appropriate time by defining the transition of risk from the seller to the buyer. As a result, there is less chance of monetary loss to the merchandise during shipment. Thus, the adoption of Incoterms can assist in facilitating successful and cost-effective international commercial operations. The section below highlights some common merits and demerits of using different types of incoterms in transactions.
Advantages and Disadvantages of Using Specific Incoterms
Generally, the type of transaction being processed determines the incoterms to be used. However, having a thorough understanding of the benefits and drawbacks of adopting these standardized trading terms can assist parties in selecting the best Incoterm for their transaction.
EXW (Ex Works)
Under this Incoterm, the buyer is fully responsible for goods when they are presented to the seller’s destination. The benefits of adopting EXW include but are not limited to its simplicity and ease of use, as well as the fact that it gives the customer total control over the handling and shipping the merchandise. However, the major drawback of this approach is that the buyer bears all transportation-related expenses and liabilities. Additionally, it could be not easy to organize the delivery of goods from the seller’s location.
FCA (Free Carrier)
According to this Incoterm, responsibility over the goods remains with the seller, and it cannot shift to the buyer unless the goods are delivered to the carrier. The benefit of employing FCA over EXW is that the former gives the customer greater control since the seller bears all the risks when delivering the goods to the carrier (De-Sousa, 2021). However, the buyer must arrange all shipment processes from the carrier’s location. This is a significant disadvantage to the buyer because there is always a chance of interruptions or damage occurring during shipment.
CPT (Carriage Paid To)
According to this Incoterm, the seller is in charge of the products before they are delivered to the carrier. Therefore, the seller covers the cost of transportation to the predetermined location (Ağaoğlu, 2020). The benefits of adopting CPT are that it eliminates the risk from the buyer during shipment and that the seller is obliged to make all transportation arrangements. The main demerit, however, is that the buyer must offload the items and handle all taxes and costs associated with customs clearance independently.
CIP (Carriage and Insurance Paid to)
This Incoterm requires the seller to have insurance to protect the cargo during shipping. The use of CIP enhances buyer protection and streamlines shipping procedures (Petrová et al., 2021). Nonetheless, the buyer remains responsible for offloading the merchandise and covers all taxes and fees associated with customs clearance. This is a significant disadvantage because part of the insurance expenses are transferred back to the buyer.
DAP (Delivered at Place)
Under this Incoterm, the custody of the products remains to the seller until they are shipped to the designated location. As a search, the goods must be unloaded by the seller (Kim, 2021). While using DAP, the seller is responsible for organizing transportation and unloading the products, which lowers the risk to the buyer during transportation. The drawback of this Incoterm, however, is that the buyer is obliged to cover all costs associated with customs clearance in addition to the possibility of interruptions or financial loss during delivery.
DDP (Delivered Duty Paid)
Under the aforementioned Incoterm, the responsibility for the products remains with the seller until they are delivered to the designated location. At that point, the seller meets any customs clearing costs and tax-related fees. Using DDP is advantageous because it simplifies transactions and guarantees the customer the utmost protection. Nonetheless, its downside is that it puts a heavy financial risk on the seller because they meet all expenses and dangers related to the delivery and shipment of the products. The segment below summarizes the key aspects to consider before selecting a specific incoterm.
What Companies Need to Know When Using Incoterms
Firms and countries should always consider the destination of purchased goods, the risks involved, and the characteristics of the products being shipped when deciding on the best Incoterm. Apart from the experience and knowledge of the entities participating in the transaction, firms need to factor in the available modes of distribution and transportation. They must ensure that they are fully aware of their obligations and liabilities under the selected Incoterm (Kim, 2022). Furthermore, buyers must confirm the transaction costs, which should include shipping, insurance, and any applicable taxes or customs clearance fees. This would ensure their sales contract is understood. Lastly, both parties should confirm whether their insurance policies would fully cover any unforeseen losses or damages that may occur during shipment.
Conclusion
As highlighted throughout this paper, incoterms serve a significant role in international trade by providing clarity and minimizing misapprehensions between transacting entities. Understanding the benefits and drawbacks of specific incoterms can assist these entities in selecting the ideal contract for their transaction. To prevent confusion and disputes, transacting firms and companies must ensure that they have a good understanding of the duties and obligations related to the chosen contract.
References
Ağaoğlu, C. (2020). Incoterms® 2020. Public and Private International Law Bulletin, 40(2), 1113-1149. Web.
De-Sousa, G. L. (2021). Incoterms, VAT and customs: International trade of tangible goods. Global Trade and Customs Journal, 16(3). Web.
Davis, J., & Vogt, J. (2022). Incoterms® 2020 and the missed opportunities for the next version. International Journal of Logistics Research and Applications, 25(9), 1263-1286.
International Chamber of Commerce (2020). Which Incoterms rule should I use? Incoterms® 2020. Web.
Kim, S. M. (2021). Right choice of DPU in Incoterms 2020. Global Trade and Customs Journal, 16(3). Web.
Kim, S. M. (2022). Some critical & controversial issues on incoterms 2020 for International Trade. Global Trade and Customs Journal, 17(1). Web.
Petrová, M., Krügerová, M., & Kozieł, M. (2021). Incoterms–history and future development. In Proceedings of the 15th International Conference Liberec Economic Forum (pp. 589-598).