As a business, it’s essential that products and services change hands between partners, distributors, retailers, manufacturers and other relevant stakeholders in a timely, safe and cost-effective manner. That's why it's useful to have an understanding of a concept in international law known as 'Free on Board' (FOB).
In this article, we’ll explain the definition of FOB, and when it can help SMEs to save money and reduce risk in the supply chain.
What is Free on Board (FOB)?
Ordinarily, when companies ship goods to customers, the seller is responsible for the goods until they physically reach the customer. However, when goods are being shipped between countries, there are a variety of international commerce terms (incoterms) that define the exact relationship between buyer and seller, and each party’s responsibilities.
In Free on Board (FOB) shipping, the buyer is responsible for goods while they are being shipped. The seller is only responsible for getting the goods to the point of shipping, such as a port.
Once the product arrives at the port, the buyer is responsible for costs such as import duties, loading costs and import duties. The buyer is also responsible if the shipment is lost, delayed or damaged.
Who pays the freight on FOB?
Typically in FOB, the seller is responsible for freight costs from the manufacturing site to the port, and then the buyer picks up the bill for ocean freight costs, explains Neil Jordan, VP of supply chain and logistics with consulting group Proxima.
“There are a number of variations to FOB that will shift responsibility between parties at different times in the supply chain, but generally the overseas freight cost will be the responsibility of the customer,” he says.
For example, in some instances, the buyer might pay freight costs, but this sum will be deducted from the seller’s invoice. This is because FOB is less about who bears the cost of freight, and more about who signs the agreement, pays the bill and ultimately takes responsibility for the shipment.
When to use FOB
FOB can be a useful shipping technique for SMEs because they do not always have access to the best services and best prices for international shipping, says Jordan. “The smaller a company is, the less volume they have to negotiate pricing. A larger company might have an office in the overseas location, existing relationships with freight companies, or a strong relationship with a local third-party logistics provider,” he says.
FOB can also help SMEs protect their reputation if they are buying from other small businesses overseas. Koua Studio is a UK-based sustainable fabric business that sells high-end fabrics to interior and fashion designers. These fabrics are sourced from artisan designers in Mexico, which presents a high level of risk, explains Erika Alvarez, the company’s CEO and co-founder.
“We know that shipments in Mexico are more likely to be opened and checked, and the product potentially damaged or delayed,” says Alvarez. “As sellers, we use FOB shipping so that our customers take on responsibility for loading and shipping the product, rather than our small business taking on that responsibility and risk.”
In many cases, the customer buying the fabric is from a larger business, and they will have existing relationships and insurance policies in place, adds Alvarez. “If not, we can provide advice on every step of the process, without needing to take on the financial and reputational risk of handling shipping directly ourselves.”
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Advantages of shipping FOB
For a small business, the key advantages of shipping FOB include:
- Benefit from economies of scale of larger customers for freight services
- Reduced risk to your reputation from delays or losses (if selling)
- Less cost associated with providing logistics support overseas
Disadvantages of shipping FOB
While FOB can be a useful way for SMEs to ship products internationally with reduced cost and risk there are some downsides to be aware of.
If you are the buyer in a FOB agreement, then your business will be liable for costs if a shipment is lost or delayed. It can also make it difficult to keep your supply chain management efficient, says Jordan. “If a ship is delayed and you’re waiting on components, then it can create scheduling problems,” he says.
FOB vs Ex Works shipping terms
An alternative incoterm to FOB might be Ex Works. This refers to an arrangement where the buyer takes control of the product sooner in the supply chain. “With Ex Works, the buyer is responsible for the transport to the boat, usually a train, or truck,” says Jordan.
This arrangement works well if the seller is an SME that doesn’t have the scale to get cost-effective freight services. Ex Works can also be helpful for high-value goods where the buyer needs to have a higher level of supervision of products such as pharmaceutical or luxury goods. “In some countries, larger buyers will know the local market well, and have existing relationships for security escorts, secure trains and their customers want to know the product has been tracked from end to end,” adds Jordan.
FOB vs cost and freight (CFR) and cost insurance and freight (CIF)
CFR and CIF are variations on FOB incoterms, referring to ‘cost and freight’ and ‘cost, insurance and freight’ respectively.
Specifically, CFR refers to an agreement that stipulates it's the seller's duty to clear goods for export, delivery and port onboarding. They are also responsible for carriage. CIF, however, refers to an agreement whereby the seller covers any costs pertaining to costs, insurance and freight of a buyer's product while in transit.
“In terms of responsibility for goods, these two incoterms look the same, the only difference is who pays for insurance," says Jordan.
As with Ex Works, choosing to use CFR and CIF should be based on a choice of who has access to the best service and pricing, the buyer or seller.
FOB vs free alongside ship (FAS)
FOB shipping asks the buyer of goods to be responsible for paying loading costs onto a ship.
In some cases, businesses may agree on FAS terms, which involve placing goods alongside the ship, but not loading them onto the vessel. FAS usually only applies to ocean freight, since it isn’t usually possible to deliver goods alongside a plane.
FAS is generally advised where the seller does not want to be responsible for a delay in berthing the vessel, a shipment being cancelled, or delays caused by congestion.
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