There was once a large, expensive customized motor that was being loaded onto an ocean freighter. As it was being loaded, the crane holding the motor’s crate swung back out over the rail and accidentally dropped the crate into the water. The Incoterm (shipping term) was FOB (freight on board), so who was responsible for the lost shipment?
I think this may have been a test question in my International Trade and Finance grad school class. The answer is: the Buyer. The reason is that with FOB, the responsibility for the shipment passes from the seller to the buyer when the shipment crossed the railing of the ship. Now hopefully the buyer insured his shipment. Otherwise this would be a costly lesson in international trade. Here are some basics that will help keep you out of trouble in
There are 13 Incoterms that help define where responsibility passes from seller to buyer. They range from Ex Works (EXW) where the buyer picks the product up from your loading dock to Delivered Duty Paid (DDP) where the seller takes full responsibility for the shipment up to the door of buyer. A lot of first-time exporters assume that EXW is the best Incoterm choice because it shifts responsibility to the buyer immediately. But that is rarely the best choice based on how much control you need to have over the delivery of your product. Please also keep in mind that several Incoterms, including FOB, cannot be used in air freight (FAS, FOB, CFR, CIF, DES, & DEQ). A great book on this topic is Managing Exports: Navigating the Complex Rules, Controls, Barriers, and Laws by Frank Reynolds. Another excellent resource is International Trade and Banking Consultant, Roy Becker (http://roybeckerseminars.com).
There are four main financing options for exports. First is for the buyer to pay cash up front. This is more common for highly customized products in high demand and for first-time buyers with no credit history in your company. Many exporters use the second option: Letter of Credit. But LOCs are very expensive and if written incorrectly can cause all kinds of complications to the sale. International bankers normally draft a LOC. They are best used for large item purchases and are less frequently used today because of their cost. The third option is Documentary Collections. In this option, the buyer cannot obtain the shipment until they have certain documents. The documents are sent to the buyer’s bank and instructions are carried out to pay the seller. Instructions usually include payment conditions. Finally there is the Open Account payment term. Open Account means that you’re extending credit to your buyer. This is a good payment term for long-time customers with good credit and fairly stable currency. Payments can be made through the SWIFT electronic payment system.
So which Incoterm and which Payment Term should you use? As with most questions in international business, the answer is- it depends. It depends on the type of product, the mode of transportation, how well you know and trust your customers, the level of involvement you have in installing the product, and your ability to repurpose your product to another customer should the original customer change their mind. To navigate these choices, I highly recommend talking with your international banker or your freight forwarder, if these are professionals you feel you can trust to act in your best interests.
Additional words of advice:
- Match your Incoterm, payment term and insurance coverage (yes, insurance!) so that the point that responsibility for the shipment passes between buyer and seller is the same point that payment is triggered (even if it’s to be paid in the future by the buyer’s bank) and seller insurance takes over.
- Find an experienced freight forwarder with small-enough operations to take your account seriously. A good FF can save you a lot of shipping expenses and help you navigate the documentation needed.
Best of success to you in all of your international business!
Onwards and Upwards,