What are Incoterms? Definition and Best Practices

Incoterms (International Commercial Terms) are a standardized set of trade rules published by the International Chamber of Commerce that define the responsibilities of buyers and sellers in international and domestic trade transactions. Specifically, Incoterms specify who bears the cost of transportation, who is responsible for insurance, and at what point in the shipment journey risk transfers from seller to buyer.

When a purchase order crosses a border, two critical questions arise: who pays for freight at each leg of the journey, and who owns the risk if goods are lost or damaged in transit? Without clear agreement on both points, disputes are common and costly. Incoterms resolve these questions with a shared vocabulary that both parties recognize, regardless of country or language.

The current version, Incoterms 2020, defines 11 terms organized into two groups. The first group (EXW, FCA, CPT, CIP, DAP, DPU, DDP) applies to all modes of transport. The second group (FAS, FOB, CFR, CIF) applies specifically to sea and inland waterway transport. Each term allocates costs and risk differently, so the choice of Incoterm has direct financial implications for both the buyer and the seller.

FOB (Free On Board) and EXW (Ex Works) are the most commonly cited Incoterms in consumer goods sourcing. Under FOB, the seller bears cost and risk until goods are loaded onto the vessel at the origin port. Under EXW, the buyer assumes responsibility as soon as goods are available at the seller's facility. The difference affects who arranges export customs, inland freight in the origin country, and ocean freight, with significant cost implications for each party.

Each Incoterm specifies three things: the point at which risk transfers from seller to buyer, which party is responsible for arranging and paying each leg of transportation, and which party handles export and import customs clearance. These three dimensions together determine who controls logistics decisions at each stage and who absorbs costs if something goes wrong.

Insurance responsibility varies by Incoterm. CIF (Cost, Insurance, and Freight) requires the seller to provide insurance coverage during the main ocean leg, while most other terms leave insurance as optional or the buyer's choice. Operations teams sourcing under terms that do not require seller-provided insurance should assess whether their own marine cargo coverage is adequate for the value of goods in transit.

For consumer goods buyers importing from Asia or Europe, the Incoterm negotiated on a purchase order directly affects landed cost. A supplier quoting FOB Shanghai includes only the cost of goods and origin-side expenses. The buyer must separately arrange and pay for ocean freight, destination port charges, customs clearance, and inland delivery to their DC. Under DDP (Delivered Duty Paid), the supplier covers all of these costs, but typically builds the freight and duty margin into the product price.

Operations and procurement teams often prefer FOB or FCA terms because they retain control over freight booking, carrier selection, and transit visibility. Buyers who control the freight can consolidate shipments, negotiate their own ocean rates, and respond faster when delays occur. Suppliers who control freight under DDP or CIF terms may use carriers the buyer cannot monitor or influence.

Incoterms should be explicitly stated on every purchase order and commercial invoice to avoid ambiguity. Disputes over who owed what during a damaged or delayed shipment are significantly easier to resolve when the Incoterm is clearly documented and both parties understood the allocation of risk at the time of contracting.

• Landed Cost is directly shaped by the Incoterm agreed on a purchase order, since the term determines which freight and duty costs the buyer must add to the supplier's price.
• Bill of Lading (BOL) is the shipment document that establishes who has title to goods in transit, and its terms must align with the Incoterm on the purchase order.
• Supply Chain Management (SCM) practices incorporate Incoterms as a standard tool for defining international supplier relationships and managing cross-border logistics costs.
• Purchase Order (PO) documents should specify the applicable Incoterm to ensure both buyer and seller agree on cost and risk allocation before the shipment departs.
• Freight Audit processes reference the Incoterm on a shipment to determine which freight charges the buyer is responsible for and should be reviewing against carrier invoices.