It's time to blow up Incoterms,1 or “International Commercial Terms,” the shorthand used in place of contract language for trade agreements. Incoterms currently are a confusing mess of contradictory, inconsistent kludges that almost certainly cost the world dearly in lost speed, efficiency, and productivity.
Indeed, research suggests most professionals do not understand or apply Incoterms with any fidelity. The resulting inappropriately applied Incoterms create risks and costs where none need be, and misalignments between expected performance and Incoterms choices mean that many logistics cycles are completed through goodwill alone, rather than through rigorous application of any standard. The only thing saving Incoterms from being a total loss is the fact that they are far better than having nothing at all.
Incoterms, or “International Commercial Terms,” were designed and published by the International Chamber of Commerce (ICC) over 80 years ago and were made to simplify trade. Prior to Incoterms, each contract had to be written to specify every aspect of the trade, such as which party was responsible for arranging and paying for all the logistics of moving the product from seller to buyer, and when the buyer would take responsibility for the goods. The ICC designed the Incoterms to serve as a universal “shorthand” for lots of long contract language across millions of trade agreements, which meant that the contract could be shorter but also that the logistics personnel effecting the contract terms could, in theory, simply check the Incoterms rule to know what responsibilities they had to fulfill under the sale.2
Incoterms define the obligations of the buyer and seller to deliver the goods in a trade. In so doing, they address the roles, responsibilities, costs, and actions of the buyer and seller to perform the logistics of moving the goods to satisfy the contract. Each rule is a three-letter designation starting with either E, F, C, or D. The “E” rules deal with goods that are exchanged at the seller’s facility, the “F” rules deal with goods that are exchanged from the seller’s facility up to (and including) the port of international departure, the “C” rules deal with goods exchanged at either the port of export or the port of import (or in between), and the “D” rules deal with the goods that are exchanged upon arrival in the buyer’s country. Incoterms are accepted globally as the trade rules for both domestic and international movements.
The original Incoterms were such an improvement over having none at all that the U.S. decided to create a similar (and incompatible) standard under the Universal Commercial Code (UCC) adopted by all U.S. states but one (Louisiana).3 These UCC rules used nearly identical language to the Incoterms rules to mean quite different things that were more loosely defined; a fact that has enormously confused matters for logistics personnel both domestic and foreign to the U.S.
To make matters worse, the UCC rules haven’t been updated at all, while the ICC spent the next eight decades updating the Incoterms to accommodate the practices of the day, but in a way that clung to legacy language and structures. These include introducing Free Carrier (FCA), a rule that seems to do the work of three rules with only context clues to differentiate, additional C rules that differ mainly by whether you want to use them on water or not, separate D rules that differ only by whether one party or another unloads the goods on arrival, and shifting the meanings, names, and usage of every other rule along the way.
Each incarnation of Incoterms is a new “Frankenstein’s monster” of additions for the sake of modernity operating alongside concessions to the inertia of historical rules, such that neither modernists nor traditionalists could hope to be satisfied. The result is an ever-increasing thickness of the Incoterms rule book trying descriptively to solve the issues of the Incoterms. The official 2020 rulebook, which features the same number of rules as the 2010 version (with some minor changes), is now about 50% larger but has not addressed the fundamental issues bedeviling them.
Our research shows these are just some of the major issues with today’s Incoterms. The extreme proliferation of international trade in the decades since its first creation only serves to increase the stakes and amplify the costs. Any improvement to the application of Incoterms would reverberate across millions of trades each year, repeated every year thereafter.
A closer look at the problem
One of the main issues with the current Incoterms is the fact that the ruleset has dragged along older rules for the sake of continuity and lived alongside the incompatible (yet superficially similar) UCC rules for decades. This has caused a great many challenges and headaches for practitioners. Consider the term Free on Board (FOB). In the 2020 rulebook, FOB is superficially identical to both the 1936 Incoterms version and the 1952 UCC code version. In each case, the seller loads onto the buyer’s vehicle. However, the original Incoterms rule was meant only for water deliveries to the vessel of main carriage, and for decades, it specified that risk passed to the buyer upon traversing the ship’s rail. Only in 2010 did this finally shift to risk passing once safely at rest on board the ship, matching the expectation set by the rule’s name. The UCC rule, by contrast, works for any kind of vehicle, can deliver anywhere, at any point in the logistics movement, and no mention is made at all of risk passing. One might expect the ICC’s Incoterms to be clearer on these points, but it is not even clearly written as to whether F rules apply only to domestic moves or whether D rules are intended exclusively for delivery after export. That partners in trade are entering into contracts with such incompatible understandings of what seem to be the same rules should give pause to us all.
Additionally, despite all its complexity, Incoterms cannot even adapt to many reasonable logistics scenarios, forcing supply chain personnel to select ill-fitting rules and then rely on countermanding contract language to warp the rule into sufficiency. Suppose you deliver to rail where risk passes once the cargo is loaded onto the railcar. It turns out there is not an Incoterms rule for this. FCA requires the buyer to do the unloading and loading onto the next vehicle along the route, as does Free Alongside Ship (FAS), and both FAS and FOB are for water-only transport. You are forced either to misuse FOB for ground transport or to use FCA and specify loading responsibilities and risk passage in the contract, hoping that this modification is honored in practice.
Finally, the Incoterms rules are inconsistently structured, adding to the challenge of retention and usage. Some rules’ three-letter descriptions refer to the point of risk and responsibility transfer, such as with Delivered at Place (DAP), FOB, and FAS. Other rules’ letters refer instead to the arrangement and payment obligations of the seller, as with the C rules. Some refer to the responsibilities of materials handling, as does Delivered at Place Unloaded (DPU), whereas other similar rules leave the practitioner to dig into the rulebook to discover these responsibilities, as with DAP, Delivered Duty Paid (DDP), and, arguably, FCA.
These examples4 and others show the fundamental rigidity and impenetrability of the current Incoterms ruleset. Too many traders negotiate deals under terms they are not prepared to understand, and the Incoterms rules, while aiding logistics and trade generally, also abet the exploitation of eager and unsavvy sales professionals. We’ll never know how many jubilant salespersons have closed a deal only to find out that the CIP (Carriage and Insurance Paid to) terms they readily agreed to entail huge extra expenses for their companies that they did not account for when negotiating the price.
Misunderstood and misapplied
Indeed, recent research has hinted that Incoterms are commonly misunderstood and misused by professionals almost regardless of their expertise.5 In a 2021 survey, industry professionals who use Incoterms were asked to provide the correct Incoterms for given scenarios. Even for the logistics scenario with the most correct responses, only 21% of procurement, sales, and logistics respondents were able to answer correctly.6
The same respondents, when asked what improvements in Incoterms they would like to see, overwhelmingly responded that simpler rules, fewer rules, and better documentation were in order, as shown in Figure 1.
Enlarge this imageFor such an important cog in our economic machinery, there must surely be an economic cost to practitioners wielding it with so tenuous a grasp. There are no available figures that estimate the cost to all of us for mistakes in Incoterms usage. Whatever that figure is, it is an invisible, pervasive, and persistent form of risk and cost that continues to be unaccounted for.
To that point, it’s worth exploring who is doing the lion’s share of Incoterms selection. Is it logistics, as might be expected given the logistics function’s outsized role in delivering the result? Is it procurement, given that function’s direct involvement with deciding the terms of any contract of sale? Is it legal? Our survey respondents report that about 67% of contracts use Incoterms that were determined by either procurement, sales, or legal, as shown in Figure 2. Fewer than 20% of contracts use Incoterms chosen by the logistics people who must perform the work and know what can and cannot be achieved economically and efficiently.
Enlarge this imageThis suggests that the function performing the work is generally not a party to the decisions about who does what, how, and when. This is, at best, a recipe for poor performance. The extent to which the research shows Incoterms are misused and misapplied means that a shocking amount of trade relies on goodwill alone to ensure delivery. Goodwill is clearly a powerful force, but it cannot be best practice to rely on it, and doing so introduces risks and inefficiencies, and places strain on supply chain relationships.
There are two possible approaches for improving the Incoterms situation: 1) educate and train everyone thoroughly on using today’s Incoterms to their best advantage, or 2) simplify Incoterms. In fact, these are not mutually exclusive. However, the first solution entails a sustained campaign to directly and permanently change the values and behaviors of millions of industry professionals, which has already been attempted and is no small task. The second entails some diligent and thoughtful work by a few smart people working with the ICC to draft the rules. This may also be no small task, but it is orders of magnitude more realistic.
A new proposal
Let’s consider a wish list for a better ruleset:
1. Simplicity: A better ruleset should begin with the goal of simplicity, which means a common and consistent structure that results in easily transferrable learning. Deeply understanding one rule should make it very easy to quickly understand any of the rules because the way they work is similar and predictable. If one element of a rule uses a letter to indicate the scope of the rule, for example, then every rule should as well.
2. Clarity: A ruleset that is clear will be one that communicates quickly and openly what each rule’s scope, purpose, and application is, leaving no room for second guessing or judgment calls. More importantly, a clear ruleset will avoid ambiguity, not only between rule descriptions but also about which rule is appropriate for a given circumstance.
3. Parsimony: A parsimonious ruleset will cover all the necessary bases with a minimum of overlap between rules, and zero unnecessary rules.
4. Completeness: A complete ruleset will provide all the power the industry needs to easily explain the obligations, risks, and costs of any trade that can be done, without resorting to using the contract language to distort the rule.
Note that the current Incoterms ruleset fails on each of these dimensions of quality, so succeeding on even one dimension should be worth a change.
We begin, then, by blowing up the ruleset and starting from first principles. As we do so, we have a few important constraints in how the new ruleset would look:
1. Each rule should be clear about where the exchange will occur, be it in the seller’s country or in a foreign country after export.
2. Each rule should hold for all modes.
3. Each rule should clearly reveal whose responsibility it is to move materials at the point of delivery, without the need to parse the rulebook.
4. Each rule should be clear about when risk transfers without relying on context or interpretation.
5. The ruleset should readily articulate every valid combination of delivery point, ultimate destination, loading terms, risk transfer behavior, and insurance.
The simplest version possible would be just two Incoterms rules. Let’s call them Free Carrier (FCA) for any movement where the delivery occurs domestic to the seller, and Delivered After Export (DAX) for any movement where the delivery occurs after export.
Let’s determine all the necessary degrees of articulation we’ll need for those two rules. First, we need to convey the point and place of delivery. Next, we need to know who will do the materials handling at transfer point. With just these two rules and these two modifiers, we can successfully re-create the bones of many of the current Incoterms, minus a few details.
To replicate the current C rules we’ll need two more modifiers: one to describe the risk transfer point and one to indicate the need for insurance. With these in place, our new DAX can specify a delivery point late in the movement but a risk transfer point early in the movement. Finally, we need to know that the newest Incoterms rules are in effect, so we’ll continue to use that modifier of Incoterms followed by the year of publication. Let’s call the new proposal “Incoterms 2030.” With all these modifiers in place, we can now replicate all of the current Incoterms. Not only that, but these two rules can handle situations that the current rules cannot, such as a situation where risk passes early, but the seller arranges shipping to the door of the customer and unloads the cargo. It can even handle situations where risk passes after the delivery point, such as a scenario where the seller unloads, and risk only passes once the cargo is installed and calibrated at the customer’s site.
Here is what the resulting two rules might look like:
1. FCA (delivery point and place, loading, risk transfer point, insurance, Incoterms 2030)
2. DAX (delivery point and place, loading, risk transfer point, insurance, Incoterms 2030)
If “risk” or “insurance” are left blank, we can have standard assumptions, such as “at the point of delivery” and “none,” respectively.
These resulting rules are so radically simple that it would be almost impossible to select the wrong rule, and the details of the resulting logistics performance are so up front that it would be almost impossible to be confused about them. Any ambiguity in the specification (such as with a missing or conflicting modifier) is front and center to both parties and forces communication to take place early to settle underspecified or wrongly specified details.
One further distinction we might want to introduce is between purely domestic sales, where the end customer is domestic and no export will happen, versus export sales, where additional due diligence and documentation is necessary. The responsibility as a seller is to ensure export compliance, and so might split our new FCA into two rules: FCD for domestic sales and FCI for international sales. This change will signal to all parties the additional responsibilities associated with the trade and prepare the seller for the appropriate degree of packaging. This change also has the benefit of ensuring that none of the new rules could be confused with existing rules, helping to establish a clean break from past usage.
Given this, our new and improved ruleset now has three rules, instead of 11:
1. FCD (delivery point and place, loading, risk transfer point, insurance, Incoterms 2030)
2. FCI (delivery point and place, loading, risk transfer point, insurance, Incoterms 2030)
3. DAX (delivery point and place, loading, risk transfer point, insurance, Incoterms 2030)
Standard language around writing these modifiers is possible. Points and places should be straightforward. Loading language could be quite straightforward as well, as there are only four scenarios: buyer loads, seller loads, buyer unloads, seller unloads as per Figure 3.
Enlarge this imageBoth buyer actions, whether it’s loading or unloading, require the same action from the seller: make the cargo available for the buyer to handle the material. As such, both can be handled by the same short-hand instruction to the seller, which is that the cargo is delivered once it is “available” to the buyer at the point and place of delivery. For the two seller actions, different instructions are needed for the seller. “Loaded” tells the seller they need to handle the cargo onto the next vehicle, be it ship, truck, rail, or aircraft. “Offloaded” tell the seller they need to remove the cargo from the arrival vehicle onto the ground at the point and place of delivery, necessitating handling equipment, perhaps.
Standard language on insurance would be “Class A,” “Class B,” “Class C,” or “None,” and the assumed terms would be 110% of the value of the cargo, consistent with current use.
The only remaining variable that is not yet handled by this proposal is that of customs clearance. Incoterms 2020 contains a rule requiring the seller to clear import customs on behalf of the buyer. There are many potential problems with such a rule, including that sometimes the contract cannot be executed because the seller lacks import privileges. We humbly suggest that matters of customs clearance, like those of payment terms and title, are best left to the contract to specify. In this proposal, DAX could be augmented—not changed—by contract language specifying that the seller clear customs, thereby re-creating the current Delivered Duty Paid Incoterm.
The resulting Incoterms 2030 ruleset would consist of three simple—yet enormously flexible—rules that are easy to learn and understand and that clearly communicate all aspects of the trade at a glance.7
It is time for the ICC to kill Incoterms as they stand today. But, like a phoenix, Incoterms must rise again made all the better to lubricate trade and logistics across the globe. Let’s make a modern Incoterms by sweeping away the historical structural problems while building on the knowledge the previous versions have generated. This proposal for Incoterms 2030 is a path forward. But the need for change is clear, and the rewards for forging this path will make the challenges seem insignificant.
Editor’s Note:This article summarizes a series of three articles that appeared on Supply Chain Quarterly’s website. For more detailed information, see “Incoterms must die!” “Incoterms must die, Part 2: A closer look at the problem,” and “Incoterms must die, Part 3: Time to simplify” on www.supplychainquarterly.com.
Notes:
1. Incoterms is a legally registered trademark of the International Chamber of Commerce.
2. C. Căruntu and M.L. Lăpăduşi, “Complex Issues regarding the Role and Importance of Internationally Codified Rules and Incoterms,” Petroleum-Gas University of Ploiesti Bulletin, Economic Sciences Series, 2010. 62(1).
3. J.A. Spanogle, “Incoterms and UCC Article 2—Conflicts and Confusions,” The International Lawyer, 1997. 31(1): p. 111-132.
4. For more detailed examples of current problems with Incoterms, please see our article, “Incoterms must die, Part 2: A closer look at the problem,” on Supply Chain Quarterly’s website at https://www.supplychainquarterly.com/articles/8258-incoterms-must-die-part-2-a-closer-look-at-the-problem
5. See for example: Vogt, J. and J. Davis, “The State of Incoterm Research,” Transportation Journal, 2020. 59(3): p. 304-324. J. Davis and J. Vogt, “Incoterms 2020 and the missed opportunities for the next version,” International Journal of Logistics Research and Applications, 2021: p. 1-24. J. Vogt, “The Use—and Misuse—of Incoterms,” TheSCXchange, 2018.
6. J. Vogt, “The Use—and Misuse—of Incoterms,” TheSCXchange, 2018.
7. For a large cross-section of possible logistics scenarios and how Incoterms 2030 would address each, please see “Incoterms must die, Part 3: Time to simplify” at https://www.supplychainquarterly.com/articles/8371-incoterms-must-die-part-3-time-to-simplify
