Incoterms are guidelines used in international trade. They define the conditions of transport, as well as the allocation of responsibilities and costs between the seller and the buyer. The most popular Incoterms are FOB and CIF. CIF is often used because, in theory, it seems convenient to the importer, especially a novice one. In this rule, the seller bears the most responsibilities and costs. On the CIF basis, however, the importer faces unexpected financial expenses. What are the pitfalls of CIF?
Incoterms CIF
The term CIF means “Cost, Insurance and Freight.” It is used only in maritime and inland waterway transport. CIF indicates that the seller covers the costs of export clearance and delivery of the goods to the ship and any costs related to damage to the goods prior to their loading onto the ship. The seller also takes the costs of issuing and sending a commercial invoice, concluding a contract for the carriage of goods to the agreed port, basic insurance, packaging, and quality control.
The buyer covers the costs of the pre-shipment inspection of the goods and pays the fees not included in the contract related to the goods during transport from the port of loading and additional fees. The buyer also takes the costs of import clearance. Therefore, he/she does not have to deal with finding a forwarder or buying insurance. At first, CIF appears to be very favorable to the importer. The additional costs, however, emerge later at the port of unloading.
Pitfalls of CIF
Importing on the CIF basis means that the importer is not aware of how much funds he/she is going to spend on the entire import process.
Insurance of goods
The risk passes to the importer as soon as the goods are placed on board the ship. As previously mentioned, the seller undertakes the cost of “cargo insurance.” However, the seller is obliged only to insurance with minimum coverage specified in clause “C” of the Institute Cargo Clauses. It is usually 110% of the contract value. If the buyer wishes so, they can conclude an additional insurance contract. The seller must be notified of such fact.
It is worth mentioning that since the seller concludes the basic insurance contract, they are its beneficiary. If the goods are damaged or lost, funds to cover the losses are transferred to the buyer, not to the importer.
Pitfalls of CIF: freight and additional fees
The freight quote that the buyer gets does not include hidden costs. The transport cost does not include reloading, Destination Handling Charge (DTHC), and other fees. Such additional costs, which only become apparent at the port of destination, are difficult to control. Importers for sure would like to avoid such situations.
Aside from that, it is common to include an additional amount in the cost of transportation, which is another means of income for the exporter.
“Bill of Lading scam”
The importer has to obtain a bill of lading to be able to collect the goods. The bill of lading is not a contract of carriage; it entitles the holder to dispose of the goods.
If the consignee does not present two of three of the original bills of lading, he/she cannot collect the cargo. Original and valid bills of lading, meaning signed and stamped by an authorized person (shipowner, carrier, or forwarder), should be delivered to the recipient. If the seller fails to do so or presents the counterparty with false documents, the importer cannot take over the shipment. It only generates additional costs, e.g. container parking costs.
Another case is when the buyer who made payment by letter of credit does not receive a lading bill. Bill of lading is required to meet the terms of the letter of credit (if the contract states so). If the goods are shipped by another means of transport, e.g. by plane, the importer will receive an air waybill instead of a bill of lading. As the terms of the contract have not been met, the bank withholds the money transfer.
Pitfalls of CIF: change of the mode of transport
Sometimes the CIF basis is misused for air or rail transportation. In this case, you must take into account obstacles at the customs border. Customs do not recognize transport on the CIF by any means of transport other than ships. The change of the mode of transport may cost you several days at the customs border.
Having no say in choosing the freight forwarder
On CIF, it is the seller that chooses the freight forwarder. Usually, they choose the cheapest options within the current contract, which may not always be convenient for the importer. For example, if they expect timely delivery or express shipment, the only option is negotiating with the other party. In this way, they can persuade the contractor to adopt their preferred conditions.
Pitfalls of CIF: loading scams
As mentioned above, the buyer may request and pay for the pre-shipment inspection. However, if they choose not to do the inspection, they have to face a high probability of being scammed. For example, it is common to fill bags with sand or the like so that the weight corresponds to the one on the packing list. Therefore, it is recommended to organize the pre-shipment inspection so that the buyer can be ensured there is no scam. The inspector may be present at loading or check the actual condition of the goods in the warehouse.
What to do in case of problems when buying on the CIF?
First off, good communication with the contractor is critical. You should set out your requirements, and the shipping conditions should be clearly defined when negotiating. If the seller does not consider Incoterms as an important factor or quotes a low transport cost, it raises a red flag. On CIF, it is expected that the costs are even higher than the amount quoted by the contractor. The letter of credit is a great protective measure, but if you use LC, you should clearly define the document on which it will be based.
Of course, you can import on CIF basis if you have a trusted business partner who will also choose a reliable freight forwarder. The seller can also recommend a customs agency that will take care of the formalities so that you do not bear high additional costs. It is worth getting to know the costs by contacting the freight forwarder and customs agency directly to be prepared for fees at the destination port. Imports on CIF are often less risky in highly developed markets, such as from the US.
To avoid unexpected import charges and other pitfalls on CIF, we recommend choosing the FOB terms. On Incoterms FOB, as an importer, you have more control over costs because you choose the forwarder. With clearly defined conditions of carriage and freight price, there is little risk of unexpected expenses at the port of destination.
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