Strategic Decision Making in Logistics – Incoterms Rules

John Vogt, former Halliburton vice president of global logistics, presents the latest in his series on Incoterms, a set rules that define the responsibilities of buyers and sellers in international and domestic trade contracts. New instalments are published each month in BreakbulkONE.

The conundrum for logistics is to choose the most appropriate means, method and route for goods to be delivered from the seller to the buyer.

If (as it should be but is often not!) the ultimate aim is to provide the goods at the most appropriate time and with the highest delivery reliability to the customer, then there are several decisions to be made before the agreement between the buyer and seller is finalized.

These range from the choice of Incoterms, how to measure and manage the logistics, plus the consideration of where goods should come from and how the cost to the company for each source and delivery option is computed (Total Cost of Ownership). This TCO is often misunderstood and badly utilized. Without a full TCO calculation, companies make incorrect decisions because they do not account for the costs plus the use of capital (yes, goods have value and tie up capital while in transit to the end customer) in their decision making.

The focus of this article is the agreement between the two parties and the Incoterms rule chosen, and whether this is chosen strategically between the buyer and seller, or just to suit the larger organization. The decision making will be looked at through the lens of choosing the most appropriate Incoterms rule, the measurement and management of the lane or lanes utilized, and then the TCO for these choices to choose the most appropriate to deliver the goods to the end customer.


Rules of the Game

The Incoterms rules allocate the obligations, costs and risks for each of the buyer and seller organizations. These rules define the roles and responsibilities for each of the logistics functions of the buyer and seller. Formal research shows the Incoterms rule is not chosen strategically nor yet by the logistics functions who must enact what is agreed.

The functions that choose the Incoterms rules are not skilled logistics professionals, which results in many cases where the logistics functions must try and make this work, often scrambling to move the goods and get the right information at the right time. This is not a good method to provide an efficient and effective movement to satisfy the customer; rather, this is a less than optimal choice and means the movement is less than efficient or effective.

The largest problem is where procurement sets a DDP rule for a supply of goods into the company so that the category has the largest spend (category managers are often measured on size of spend in the category), and the movement and information flow is performed by the suppliers leaving the procurement department to merely coordinate the supplier’s performance.

If you think this does not happen, history shows that a major supplier that was forced to give their price at the loading port versus delivered to the final port, marked up their logistics cost by 20 percent. That is correct – the supplier took a 20 percent premium on its logistics cost for their risk and work. If your logistics department can do this equally or better, this is pure profit to the company. And this is why logistics departments must be more than oversight managers of freight forwarders!

To be strategic in the choice of the Incoterms rule would imply the choice of the rule is done by the buyer and seller, and would take into account the skills, buying power and overall capabilities of the logistics functions to move the goods in the most efficient and effective manner. This would mean that every movement from the source to an end destination is looked at critically, and this rarely happens as most companies choose their standard Incoterms rule before the contract is set, rather than for each contract lane of movement when agreements are negotiated.

Strategically, that means a clear understanding of the capabilities of the buyer and seller logistics departments in each lane – that is, from a source to an end destination – and for each mode. It must be evident that an organization may well be extremely good at logistics and have great capabilities with moving containers or airfreight. But it might well not have any skill in bulk shipping, which is a specialty, for a specific lane.

In this case the choice for the Incoterms rule will be strategically chosen to favor the booking for the bulk ship, at the least, to be in the hands of the logistics department with the dominant skill. This narrows the choice of Incoterms rule to a few, which will then be looked at in the light of other factors such as customs brokers and land transport capabilities.

Strategically, the choice of who carries out customs clearance is also of major importance. Many companies have chosen to focus on customs brokers to improve their cycle time, thereby speeding delivery and making these deliveries more reliable.

The ability to deliver the correct documentation and information to a customs broker electronically speeds up the processing time and ability to move goods from one country and into another country and reduces the risks.

In earlier articles the need to create commercial invoices by the seller has been emphasized, as the creation by third parties does not remove the responsibility for accuracy and precision from the seller. Companies that rely on the documents, including commercial invoices, necessary for the importation of goods, being delivered by email and then transcribed or copy typed by the customs broker face delays and data problems. A copy typist can and will make mistakes. It will take time to do this and checked and then submit it to the customs authority.

Then comes the duty payment which many companies struggle with as they have multiple levels of authority for these larger amounts in foreign countries. Strategically, the choice of the buyer or seller to appoint the broker will be largely done by the capability of the logistics department to minimize the cycle time and the risk.

Consider a supplier who has a large amount of the goods moving from its manufacturing facility through a port. It has integrated communication with the chosen brokers and produces commercial invoices through its systems. A buyer who does not have that capability would be less than sensible to insist it perform the export clearance just because it is their policy to do the export clearance.

The choice of Incoterms rule is then either done to service the customer, or it is done poorly and sub-optimally. If done to service the customer, then the capabilities of the logistics functions must be known objectively in each lane, so they can be compared along the route and the best capability allocated to each appropriate logistic function of the buyer or seller so that the overall movement is the most efficient and effective. These reflect the principles of the strategic choice of Incoterms rules.

The remaining parts of decision making in logistics will be dealt with in the next articles, with measurement and managing of performance covered next, followed by the financial TCO aspect.


About the author:

John Vogt has his own consulting company and, at the end of his 42 years in industry around the world, was the Vice President of Global Logistics for Halliburton. Thereafter he spent five years as a Professor of Record for the University of Houston-Downtown MBA for International and Supply Chain courses. He has experience as a Board Director and has travelled the world to improve trade. In his career, he has driven the correct use of Incoterms as part of the trade improvements he has implemented to drive efficiency and effectiveness.