Incoterms explained: EXW, FOB, CIF and DDP

What an incoterm settles, and what it does not

An incoterm is a three-letter shorthand for two questions: who pays for which part of the journey, and at what point the risk of loss or damage passes from seller to buyer. Every quotation you receive from China has one attached, and it is the reason two quotes for the same goods can differ by hundreds of pounds without either being wrong.

It is equally important to know what an incoterm does not settle. It does not decide who owns the goods, it does not decide who can recover import VAT, and it does not transfer your obligations as a UK importer to anybody else. Those follow different rules, and assuming the incoterm covers them is where expensive misunderstandings start.

The four you will actually meet

EXW, ex works, means the goods are available at the factory gate and everything after that is yours: inland transport in China, export clearance, freight, insurance, UK clearance and delivery. The unit price looks lowest and the buyer carries the most work and risk. For a first-time importer it is usually the wrong choice, because export formalities in China are awkward for a foreign buyer to arrange.

FOB, free on board, means the supplier delivers the goods loaded on the vessel at the named Chinese port and handles export clearance, with cost and risk passing to you from that point. This is the most common basis for sea freight from China and generally the most practical for a UK SME, because it splits the journey at a clean point and lets you choose and control your own freight forwarder.

CIF, cost insurance and freight, means the supplier arranges and pays sea freight and insurance to the named UK port. It sounds convenient, and the catch is that the supplier chooses the forwarder, which means the charges at the UK end are set by someone you did not appoint and have no leverage over.

DAP and DDP are delivered terms, where the supplier takes the goods to your address. Under DAP, import duty and taxes remain yours. Under DDP the supplier undertakes to handle them too, which is where the trouble starts.

Why FOB is usually the sensible default

It gives you control of the expensive half of the journey. Freight, UK terminal charges, clearance and delivery are all bought by you, from a forwarder you selected, at prices you can compare.

It also makes quotes comparable. Once several suppliers quote FOB from the same port, the difference between them is the goods, not a bundled transport arrangement with an invisible margin in it.

The usual objection is that arranging freight sounds difficult. In practice you appoint a forwarder once, give them the supplier's contact details, and they take it from there. The learning curve is one shipment long.

The DDP trap, which is a real one

DDP looks like the easy option: one price, delivered, nothing to arrange. For UK importers buying from China it deserves genuine caution.

The problem is import VAT. Under DDP the seller normally arranges the import declaration and pays the duty and import VAT, often through their own agent. Entitlement to recover import VAT follows ownership of the goods, and under DDP the seller frequently still owns them at the point of import, so the person who paid the VAT may not be the person entitled to reclaim it, and you may not have a valid import VAT certificate in your own name to support a claim.

The practical outcome is a business paying twenty per cent it did not expect and cannot recover, on a shipment that looked cheaper than the alternatives. If a supplier offers DDP, ask whose EORI number will be used, who will be shown as importer, and whether you will receive an import VAT certificate in your own name. If the answers are vague, DAP is usually the better term than DDP: the supplier still delivers to your address, but you are the importer of record, so the entry and the recovery right are yours.

Our guide to the DDP import VAT trap goes through this in detail, and it is worth reading before you accept a delivered quote.

Risk, insurance and the gap people forget

The incoterm sets where risk passes, so it also sets where your own insurance needs to start. Under FOB, risk passes when the goods are loaded, which means the sea voyage is your exposure even though the supplier arranged the booking.

Under CIF the supplier insures the voyage, but often to a minimum level that may not reflect what your goods are worth or what you would actually claim for. Read the cover rather than assuming it is adequate.

Marine insurance is inexpensive relative to the value of a container. Buying your own, at a level you have chosen, is one of the cheapest pieces of protection in the whole chain.

Getting it right in practice

Always name the place with the term: FOB Ningbo, not simply FOB. The named port or address is what makes the term operative, and a term without a place is an argument waiting to happen.

Ask what is included and what is not, explicitly. Export packing, palletising, inland haulage to the Chinese port, and export documentation are common exclusions that surface later as additional charges.

Compare quotes on the same basis. An EXW price and a CIF price are not comparable numbers, and converting them into landed cost per sellable unit is the only way to see which is actually cheaper.