Article summary:
- FOB and CIF are International Commerce Terms (Incoterms), which are legally binding shipping agreement models.
- FOB gives the buyer more control over the goods during transit but imposes more responsibilities.
- CIF provides the buyer with more peace of mind but is a more expensive option.
When buying or selling goods internationally, both the buyer and the seller must agree on the terms and conditions specific to shipping. The two most common options are abbreviated as CIF and FOB.
In international trade terminology, FOB stands for “Free On Board,” whereas CIF means “Cost, Insurance, and Freight.” Each refers to a specific agreement model specifying which parties are responsible for the shipment until it reaches its destination, who is liable in case of incidents, and how responsibility transfers from one party to the next.
When shipping items internationally, fully understanding the differences between each model and which to use is critical to ensure you’re making the best and most cost-effective choice.
Overview of International Commerce Terms
FOB and CIF are two types of International Commerce Terms, often shortened to Incoterms. An Incoterm is a trading agreement model established and regulated by the International Chamber of Commerce. Although they are not laws or contracts on their own, Incoterms provide a set of terms and agreements that can be easily incorporated into trading and shipping contracts, giving them legal recognition.
As of 2021, the ICC defines 11 different Incoterms in the Incoterms 2020 Rules. The first seven Incoterms can be used with any transportation method (by sea, air, or land): EXW (Ex Works), FCA (Free Carrier), CPT (Carriage Paid To), CIP (Carriage and Insurance Paid To), DAP (Delivered At Place), DPU (Delivered At Place Unloaded), and DDP (Delivered Duty Paid).
The last four may only apply to transportation by sea or inland waterways (rivers, lakes, etc.): FAS (Free Alongside Ship), CFR (Cost and Freight), and the two most common, FOB (Free On Board) and CIF (Cost, Insurance, and Freight).
Each Incoterm defines a set of rules establishing which parties are responsible and liable for the transported goods, under which circ*mstances, and when the responsibility shifts from the seller to the buyer.
FOB: Free On Board
Free On Board is one of the two most commonly selected Incoterms. When selecting a FOB agreement, there are two possible variables: when responsibility and liability are transferred from shipper to buyer (FOB Origin or FOB Destination) and who is responsible for the freight charges (Freight Collect, Freight Prepaid, or Freight Prepaid Charged Back).
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FOB Variables and Conditions
Liability transfer:
- FOB Origin: The buyer is responsible for the goods at the point of origin. In other words, the buyer has ownership, responsibility, and liability for the goods the moment the seller loads all goods onto the transport vehicle.
- FOB Destination: The seller maintains ownership and responsibility for the goods while in transit to their destination, only transferring them to the buyer when they gain access to the goods.
Freight charges:
- Freight Collect: The buyer pays for all freight and shipping charges ahead of time.
- Freight Prepaid: The shipper or seller pays for all the shipping costs, effectively functioning as free shipping for the buyer
- Freight Prepaid Charged Back: The shipper transfers the freight and shipping costs to the invoice sent to the buyer.
- Under FOB Origin, Freight Prepaid, Charged Back, the buyer must pay a higher price from the start, as the freight costs are added to the initial price of the goods.
- Under FOB Destination, Freight Prepaid, Charged Back, the seller pays the freight charges and remains fully responsible for the goods until they are delivered, at which point the buyer subtracts the freight charges from the invoice.
In total, each variable allows up to six possible combinations of FOB agreements. The most common FOB is FOB Origin, Freight Collect. Under these terms, the buyer pays for all charges (goods and shipping) ahead of time. The buyer becomes responsible for the goods as soon as they are in transit.
FOB Situation Example
In this example, the ABC company wishes to buy a shipment of lithium-ion batteries from another company, Power XYZ. The batteries are packaged in custom shipping boxes and shipped by sea in containers.
If both parties agree to FOB Origin, Freight Collect shipping terms, the process is as follows:
- Power XYZ transports the lithium-ion battery packaging from their warehouse to a freight vessel of ABC’s choosing.
- Power XYZ completes the requirements necessary to clear goods for exportation in their country.
- The freight forwarder confirms reception of the goods, so the responsibility and liability for shipping lithium batteries shifts from Power XYZ to ABC.
- The buyer must assume all relevant risks and costs during transit until they reach their destination.
Advantages of FOB
Choosing FOB Incoterms presents numerous advantages for both buyers and sellers. FOB is a more cost-effective solution than CIF for buyers because shipping fees are typically lower than those associated with CIF terms.
Additionally, it grants buyers more control over the goods they purchase, giving them the ability to choose which freight forwarding service they want. In case of incidents during transit, the buyer also has access to more information, giving them more leeway to solve issues directly.
FOB is an almost risk-free option for sellers, as they only have to assume responsibility for the goods while they are in the warehouse. Once loaded into the vessel or transport vehicle, the seller’s responsibility ends, and they can consider the sale or transaction complete.
If you are a buyer familiar with import/export laws and international shipping regulations, FOB is one of the best options available. It is a cost-effective option that gives you flexibility and a high degree of control over your goods.
Disadvantages of FOB
FOB shipping places a lot of responsibility on the buyer because they are legally liable for the goods when they leave the seller’s hands.
Consequently, the buyer must be familiar with all relevant import/export laws, regulations, and technical intricacies associated with international shipping. Mistakes and incidents may result in costly penalties.
For these reasons, FOB is generally not recommended for new or inexperienced buyers, at least until they gain more familiarity with import/export laws and processes.
CIF: Cost, Insurance, and Freight
CIF is the most common alternative to FOB. CIF terms are generally simpler than FOB, as there are fewer variables or optional conditions.
Under CIF, the seller covers all costs associated with shipping (including insurance and freight, hence the name) until the goods reach their destination, at which point responsibility shifts to the buyer.
CIF shares the liability more evenly; the seller assumes responsibility for the goods from their facilities to the port of destination, then the buyer accepts responsibility from the port of destination to their warehouse.
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Seller and Buyer Responsibilities Under CIF
While the goods are under the seller’s responsibility, they must fulfill the following obligations and responsibilities:
- Purchase all necessary export licenses for the products
- Inspect and verify the goods
- Pay for all loading, shipping, and freight charges to the port on the seller’s side and from the seller’s port to the buyer’s port
- Assume all cargo packaging and exporting costs, including customs clearance and taxes
- Pay for insurance, covering the shipment until it reaches the buyer’s port
- Deliver the goods to the transport ship within an agreed-upon timeframe between seller and buyer, with proof of loading and delivery
- In case of an incident resulting in the damage or transportation of the goods before they reach the buyer’s port, the seller must cover all costs
Once the goods reach the buyer’s port, responsibility and liability immediately shift to the buyer. They must assume the following obligations:
- Pay for any relevant customs duty charges and importation fees
- Once the transport vessel has arrived at a port terminal, the buyer is responsible for unloading the goods from the ship
- Transfer the goods from a terminal to suitable transport vehicles
- Transport the goods to the buyer’s warehouse (or final intended destination)
CIF Situation Example
In this example, the DEF company wishes to purchase a shipment of crude oil from Petroleum XYZ equivalent to 40,000 standard shipping barrels. The oil will be transported by sea on a vessel operated (or subcontracted) by Petroleum XYZ.
If both parties agree to a Cost, Insurance, and Freight contract, the shipping process will follow these steps:
- Petroleum XYZ transports the oil from their facility to the port of origin, loading it into a dedicated crude oil tanker.
- Petroleum XYZ clears all exportation and customs requirements, acquires insurance for the cargo, pays for all associated costs, and sends documentation to DEF proving the oil has been loaded and is en route.
- Once the crude oil tanker arrives at the destination port, DEF assumes responsibility for the cargo after paying all importation and customs duty fees.
- DEF can then unload the oil from the vessel, transferring it into tanker trailers, and transporting it to its final destination.
Advantages of CIF
The main advantage for both parties under a CIF agreement is responsibility and risk management are shared roughly equally. The seller only has to worry about the cargo as long as it is under their control. Likewise, the buyer is only responsible for the goods from the moment they gain access to it at the destination port onwards.
An additional advantage for buyers is convenience and peace of mind. The buyer is not responsible for any incidents or problems during transit or at any point before the goods reach the destination port, making it an ideal solution for new and inexperienced buyers.
For sellers, an advantage of CIF is the possibility to include shipping, insurance costs, and additional fees in the invoice, potentially increasing their profit margin.
Disadvantages of CIF
The primary disadvantage of a CIF agreement, compared to FOB, is cost. Buyers must pay a higher premium because sellers will include shipping and insurance costs in the invoice.
Additionally, even though sellers must provide documentation to the buyers, the buyer has no control over the shipment before it reaches the destination because ownership and responsibility have not yet been transferred to them.
The main risk for sellers is they are fully responsible for the goods until they reach the destination port. If any incident occurs before the goods reach the destination port, it is up to the seller to compensate the buyer. Typically, the seller is obligated to either reproduce the lost goods or reimburse the buyer with the insurance money. These situations can create significant legal and communication issues.
When Should I Buy CIF vs. FOB?
As a buyer, if you are new to international trade and shipping, or if you only need to ship small quantities of goods to and from overseas, CIF eliminates many of the risks and potential hassles for you.
Under CIF, your supplier is responsible for ironing out most of the details regarding exportation, shipping, and insurance; all you have to worry about is paying importation fees and transporting your goods from the destination port to your facilities.
However, it also means the seller can choose the freighting service that delivers your goods, and that service is not required to communicate directly with you. In other words, you depend entirely on the seller for updates or information regarding your cargo’s status.
As you buy more and gain further experience and familiarity with international laws, especially if you wish to buy in higher quantities, you may find FOB a more attractive solution. Even though it imposes more risk and responsibilities onto you, it becomes a more cost-effective approach.
Under FOB, you get to choose your freight partner, which means they are more likely to have your interests in mind instead of your supplier’s. You also gain access to more information on your goods during transit (more frequent updates, better communication), which lets you address any potential issues and problems more easily.
The Bottom Line
Understanding the many rules and intricacies of international shipping can be challenging, and running afoul of one of the many laws and regulations covering them can result in hefty penalties. Always ensure you are familiar with all applicable laws when buying or selling products internationally.
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We also offer free helpful resources and information to help you ship goods across national borders more efficiently, whether by sea, air, or land. For any questions or requests regarding packing or shipping, contact us today.
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