Perhaps the most important question concerning the Incoterms® rules is, which Incoterms® rule should my company choose in a given case?

What is the commercial reality – are there any restrictions?

The commercial reality is that many companies just continue to use the same trade terms they have always used, e.g.: ‘My grandfather shipped FOB, my father shipped FOB, so I ship FOB.’ Moreover, in some cases, government restrictions require companies to limit themselves to certain terms. For example, in certain countries there are foreign exchange restrictions under which domestic buyers are required to buy on the cheapest terms allowed by national laws concerning international transactions, (which often means FCA or FOB), and to sell on the most expensive terms allowed by these laws (often CIP or CIF). These kinds of laws and regulations are less common than in the past as economies around the world have opened up and governments have begun to realize the enormous economic returns to be made from trade facilitation.

The continued existence of these kinds of regulations in some countries is lamentable and unfortunate. By restricting parties in their choice of Incoterms® rules, governments reduce the options available to traders, and raise transaction costs. Economic growth in the export sector is thereby restrained. One can only hope that governments worldwide will make trade facilitation, and the elimination of these kinds of regulations, one of their highest priorities.

How do I choose an Incoterms® rule? How do I know if my counterparty’s choice is good for me?

These are the crucial questions that face not only the beginning exporter or importer, but also the experienced trader. Whenever the trader has to deal with a new type of sale, an unfamiliar party, an unknown transport provider, or some other source of uncertainty, it is important to consider wisely the choice of Incoterms® rule.

In all international sales negotiations, the overall commercial context and the relative bargaining power of the parties will determine many of the issues covered by the Incoterms® rules. Some of the following basic principles, ‘rules of thumb’, and common notions are worth noting (they are by no means the only possible cost considerations):

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  1. Many disputes arise concerning payment of loading or unloading charges, charges arising from handling the goods in terminals, container rental charges, and/or customs processing charges. This happens even when the parties have clearly chosen a particular Incoterms® rule, because in some cases the Incoterms® rule is quite general. Why not just make a checklist of such potentially troublesome issues and clarify them systematically with your counterparties? If necessary, include language in your contract in addition to the chosen Incoterms® rule so that it is clear that you have a particular allocation in mind that is more detailed than the basic rule set out in the chosen Incoterms® rule (e.g., ‘FOB Baltimore Port, stowed and trimmed’).
  2. Many small or beginning exporters like to quote EXW (Ex Works) because they perceive that it requires the least amount of knowledge of export procedures, and the least work. This is basically accurate, but there are a number of concerns about using EXW in international transactions (see the Guidance Note for EXW at page 15) and exporters are well advised to consider using EXW, if at all, only for domestic sales. Moreover, if an exporter limits itself to agreeing to sales using only one Incoterms® rule, he or she may miss opportunities for sales in those cases where the buyer insists on other Incoterms® rules, such as FCA, CIP or DAP. So it is important for even small exporters to understand the full range of Incoterms® rules, because someday they may be called for. Moreover, even small exporters usually have access to the services of a freight forwarder or a transport carrier. These transport service providers can often counsel the small trader on how to choose amongst the different Incoterms® rules, and they may then also offer the services associated with fulfilling the trader’s transport obligations under the given Incoterms® rule. However, to delegate such responsibilities to the freight forwarder intentionally, it is preferable for the trader to have a good general understanding of the Incoterms® rules. The same kind of thinking applies to small importers who believe that they should only buy DDP, since it requires the fewest obligations on their part; they may be right, but there are many opportunities for complications in transactions using DDP (see the Guidance Note for DDP at page 20), so a thorough knowledge of all Incoterms® rules is still necessary.

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  1. The Incoterms® rule chosen will vary primarily according to whether it is the seller or the buyer who has to effect the main transport. The first practical issue is therefore: Who wants or proposes to take care of transport? Who can obtain the cheapest transport rates? There is a strong economic argument in favour of allocating the larger portion of transport duties to whichever of the parties can obtain the cheapest or most efficient transport services.
  2. The next practical issue is to consider at what point risk will transfer from the seller to the buyer. If you are the seller, you would like to transfer this risk as soon as possible; you can do this to some extent with EXW, FCA, FOB, CFR, CIF, CPT and CIP, depending on which point you choose as the named delivery point. If you are the buyer, conversely, you might wish to accept no risk at all for the goods until they are safely in your possession; then your preference would be for the D family of Incoterms® rules, DAT, DAP, and DDP. The actual choice, again, will depend on the entire commercial context, as well as on the relative interests and bargaining power of the parties.
  3. Does the choice of an Incoterms® rule require you to effect customs formalities or pay duties in a foreign country? If so, better check to make sure you know what will be required of you. It might be advisable to ask for a clause allowing you time-extensions and force majeure termination if there are customs problems.
  4. As an exporter, would you like to earn money by charging a commission for arranging transport services? If so, you may wish to choose an Incoterms® rule that places a lot of transport responsibilities on the seller (such as the C and D families of rules), so that you can then earn revenues on the provision of these services. Even if you do not want to earn money on transport, if you are able to find or organize cheaper transport than your buyer or your competitors, it may be to your advantage to quote C or D rules, because your total offer will then be cheaper and more competitively priced.

To see sample decision-making flowcharts regarding the choice of an Incoterms® 2010 rule, see Annex 2. Note, though, that any flowchart is necessarily very general and should be considered only as a starting point for thinking about which Incoterms® rule to choose. As noted in point 4 of the checklist, above, in any given real-life transaction, there are a number of considerations particular to that deal that parties must factor in to their final decision on which Incoterms® 2010 rule to choose. A flowchart alone cannot provide the answer.