Incoterms Explained: The 11 Rules and Who Pays for What
An Incoterm is a three-letter code on a quote or invoice that decides two things: who pays for each leg of shipping, and at what exact point the risk passes from seller to buyer. Get it wrong and you find out the hard way, usually when a pallet gets damaged and nobody agreed whose problem it was. This is Incoterms explained without the jargon, so you can read a term like FOB or DDP and know precisely what you owe and what you own.
Incoterms are published by the International Chamber of Commerce. The current set is Incoterms 2020, and there are 11 rules. Seven work for any mode of transport (road, rail, air, sea, or a mix). Four are only for sea and inland waterway freight.
What an Incoterm actually decides
Every Incoterm splits three responsibilities between seller and buyer:
- Cost. Who pays freight, export clearance, insurance, import duties, and unloading.
- Risk. The single point where damage or loss stops being the seller's problem and becomes the buyer's. This is the part people miss.
- Obligations. Who arranges carriage, insurance, and customs paperwork.
The key thing to hold onto: cost and risk can transfer at different points. Under CIF, for example, the seller pays freight all the way to the destination port, but risk passes to you the moment goods are loaded on the ship at origin. If the container goes overboard mid-ocean, the seller already paid the freight and you still eat the loss. That gap is where disputes live.
The 11 Incoterms 2020 rules
For any mode of transport (7)
| Term | Full name | Seller's job ends when... |
|---|---|---|
| EXW | Ex Works | Goods are ready at the seller's door. Buyer does everything else. |
| FCA | Free Carrier | Goods handed to the buyer's carrier, export cleared. |
| CPT | Carriage Paid To | Seller pays freight to destination; risk passes at first carrier. |
| CIP | Carriage and Insurance Paid To | Same as CPT, plus seller buys all-risk insurance. |
| DAP | Delivered at Place | Goods arrive at destination, ready to unload. Buyer clears import. |
| DPU | Delivered at Place Unloaded | Same as DAP, but seller also unloads. |
| DDP | Delivered Duty Paid | Seller delivers, cleared and duty paid. Buyer does nothing. |
For sea and inland waterway only (4)
| Term | Full name | Seller's job ends when... |
|---|---|---|
| FAS | Free Alongside Ship | Goods sit alongside the vessel at the origin port. |
| FOB | Free on Board | Goods are loaded on board the vessel. |
| CFR | Cost and Freight | Seller pays freight to destination port; risk passes at loading. |
| CIF | Cost, Insurance and Freight | Same as CFR, plus minimum insurance. |
A useful mental model: the terms run from least seller responsibility (EXW, you collect it yourself) to most (DDP, it lands on your dock with duties paid). Everything else sits on that spectrum.
Read them by their first letter
The first letter tells you roughly how far the seller's duty reaches:
- E (EXW). Seller does the minimum. Goods available at their premises.
- F (FCA, FAS, FOB). Seller hands off to a carrier the buyer arranged. Main freight is on the buyer.
- C (CPT, CIP, CFR, CIF). Seller pays the main freight, but risk still transfers early, at origin.
- D (DAP, DPU, DDP). Seller carries risk all the way to the destination.
Memorize that and you can decode most terms on sight. The C group is the trap, because paid-for freight makes people assume they are covered when they are not.
A worked example: EXW vs DDP
Say you are buying 500 units at 8.00 each from a supplier overseas. Goods value is 4,000. Add these landed costs:
- Origin handling and export clearance: 250
- International freight: 900
- Insurance: 120
- Import duty (say 6 percent of goods value): 240
- Destination handling and delivery: 180
Under EXW, the price is 4,000 and every one of those line items is yours to arrange and pay. Your true landed cost is 4,000 + 250 + 900 + 120 + 240 + 180 = 5,690. You also own the risk from the seller's door, and you handle customs on both ends.
Under DDP, the seller quotes one number that folds all of it in, so you might see 5,750 delivered. Slightly higher on paper, but you arrange nothing, clear nothing, and carry no risk until it hits your dock.
Neither is automatically better. EXW gives you control and often a lower total if you already have freight and customs sorted. DDP is simple and predictable, which is worth a premium when you are shipping into a country you do not know. The mistake is comparing a 4,000 EXW price against a 5,750 DDP price and thinking DDP is 44 percent more expensive. It isn't. You just moved where the costs show up.
How to pick the right term
Work through these in order:
- Where do you want risk to transfer? If you lack insurance or local knowledge at origin, push for a D term.
- Who has the better freight rates? Whoever books more volume usually gets cheaper carriage. Let them own that leg.
- Who clears customs better? Import clearance in your own country is far easier for you (DAP). Making a foreign seller do it (DDP) can cause delays and hidden fees.
- Do not use FOB for containers. FOB, CFR, and CIF are written for goods loaded over a ship's rail. For containerized cargo handed to a terminal, FCA, CPT, and CIP fit the actual handoff and protect you better.
- Always name the place. An Incoterm is incomplete without a location: "FCA Shanghai Port" or "DAP 14 Warehouse Rd, Toronto." No place, no clarity.
Why this belongs in your inventory system
Incoterms are not just a purchasing detail. They change your true cost per unit, and that flows straight into pricing, margin, and reorder math. If your landed cost calculation ignores the duty and freight baked into an EXW purchase, every downstream number is wrong.
This is where tracking helps. Inventoros lets you record supplier terms and landed costs against each purchase order and product, so the cost you plan around is the real one, not just the goods price. It is free, open source, and self-hosted, so your supplier terms and cost data stay on your own server. You can pull it all programmatically through the REST and GraphQL API, and the documentation covers install on cPanel, a VPS, or Docker.
Incoterms look intimidating because they are a wall of acronyms. They are really just a clear agreement about who pays and who is on the hook, written once so nobody argues later. Learn the four letter groups, always name the place, and calculate your landed cost off the real term, not the sticker price.
FAQ
What is the difference between FOB and CIF? Both are sea-freight terms and in both, risk passes to the buyer when goods are loaded on the vessel at origin. The difference is cost. Under FOB, the buyer pays international freight and insurance. Under CIF, the seller pays freight and a minimum insurance policy to the destination port. FOB gives the buyer more control over carriage; CIF is simpler but you inherit risk despite the seller paying freight.
Which Incoterm is best for a first-time importer? DAP is often the sweet spot. The seller delivers to your address and carries the risk the whole way, but you handle import clearance in your own country, where you understand the rules and avoid a foreign seller mishandling your customs. DDP removes even that, but sellers sometimes pad the price or hit delays clearing customs in a country they do not operate in.
Are Incoterms legally binding? They are binding once both parties reference them in the contract, for example "CIF Rotterdam, Incoterms 2020." They govern cost, risk, and delivery obligations, but they do not cover payment terms, transfer of title, or what happens on breach. Pair them with a proper sales contract.
Do Incoterms include insurance? Only two require the seller to buy it: CIP (all-risk cover) and CIF (minimum cover). Under every other term, insurance is optional and whoever holds the risk for a given leg should arrange their own. Never assume you are covered because the seller paid freight.