Incoterms: Getting Back to Basics

John Vogt, former Halliburton vice president of global logistics and a visiting professor at the University of Houston-Downtown, presents the latest in his series on Incoterms, the internationally recognized set of trade rules that sellers and buyers must follow when devising a contract for the shipment of goods. This week, John drives home the absolute necessity of choosing the right Incoterms rules for effective trade.

New installments are published on the Breakbulk news page and in our online BreakbulkONE newsletter.

It is always interesting to watch the industry and its reaction to markets. One would think that the world was ending with the use of tariffs to effect trade and negotiations. Social media allows untold “experts” to have a say with no consequences or thought, and even worse, to be wrong with no consequences.

But which international trade lane has not had to deal with changes to tariffs, taxes, and/or regulations in its last decade? If you are in the logistics world, you had better be used to seeing “geopolitical” events in your future, planning for them and then ensuring they have as little impact as possible.

It is the people who do not plan who are “crying” when these events overtake them. It is just like the repeated requests one sees in LinkedIn for strategic planning requests. If you cannot do your own strategic planning, how do you justify being a leader and manager?

Precision of trade should be dealt with by the use of the correct Incoterms rule and the understanding of the details of who does what in the trade specified in the rule. And the rules do provide these if they are understood and correctly chosen.

This last piece of the puzzle is what some new research shows is not valid in many of the trades today – there is limited understanding that poor choices of the rules compound this problem. The latest research appears in two papers (remember, research papers are checked by multiple experts to deliver the correct conclusions).

The first is the subject of this article, while the second paper is very intriguing as it presents a model which offers the most appropriate Incoterms rule based on specific situations. It uses data available globally to derive these appropriate rules for they are chosen to improve the strategic value of the trade. This will be covered in the next article.

Choosing Your Incoterms Carefully

The research shows that by and large the choice of Incoterms is not done with care and thought to achieve the satisfaction of the end customer. Rather the choice is done by standard rules written into agreements that are just utilized without understanding. Most companies use only one or two Incoterms rules for all trades, irrespective of whether they are buying a few parts or major purchases. Shame on them for not utilizing the rules to support effective trade!

Equally egregious is the general assumption that people will choose a trade Incoterms rule to give the buyer or seller who has the best logistics capability the opportunity to use this buying power and skill to help make the trade effective. Research shows there is no correlation for the choice of the Incoterms rule and the capability of the two parties, even for self-styled Incoterms “experts”.

In fact, the Incoterms “experts” failed to have a correlation to correct answers for a range of scenarios and did not have any correlation for choosing the most appropriate party of the buyer and seller to carry out the main carriage. This implies that Incoterms are largely chosen to suit one of the buyer or seller, not to make the logistics chain effective and efficient.

The research added some choices to the cases the people involved in trade were considering. which were figments of the imagination of the researchers. Low and behold the EXW International (a figment of the researchers’ imagination) was a significantly chosen option. But even more problematic is the use of FOB for containers (the ICC rule book states this should not be used for containers moving through a container terminal) and D terms for domestic deliveries (D terms imply customs formality and do not replace FCA for domestic moves). These are all incorrect.

This is disappointing and distressing as many of U.S. companies choose a rule of FOB delivered which is NOT an Incoterms and hence not accepted internationally.

The research drives us to some inescapable facts. Incoterms rules are complex, and people need to be educated in the use of these rules. Education is not from local “experts”, but from people with wide experience in trade, which is varied by mode, region and timescale and accompanied by detailed knowledge of the Incoterms rules in trade agreements. This does not include most of the consultants.

The research shows the choice of the rule should be determined by the trade partners’ logistics skills and buying power, as well as the lane risk and cost, not just which company has one or two terms in their standard agreements.

Every trade lane is unique and deserves a specific Incoterms rule to be chosen to make the trade flow as well as circumstances allow. This is achieved by using the strengths of the buyer or seller to perform each of the portions of the logistics at the highest service standard, lowest risk and the lowest cost in the best possible time. That is what logistics is supposed to be focused on.

The research also questions the existing training to utilize Incoterms rules correctly, which is largely informal and not of high quality. Every piece of research shows that Incoterms “experts” are not generally experts, even if they are the best in their company. You must understand trade, identify the strategic drivers for your company and the trade lane, and be aware of the nuances of each Incoterms rule.

Photo credit: Port of San Diego