Free On Board (FOB) is one of the most widely used International Commercial Terms (Incoterms) published by the International Chamber of Commerce (ICC). Understanding the FOB term is foundational for businesses engaged in global trade because it precisely dictates the allocation of expenses, responsibilities, and liabilities between the seller and the buyer. When parties agree to a transaction under FOB, they establish a clear framework determining who pays for each part of the journey and when liability for the goods shifts. This standardization provides clarity in international contracts, enabling companies to accurately price goods and manage complex cross-border logistics.
Defining the Free On Board Incoterm
The term Free On Board is a specific Incoterm that applies exclusively to transactions involving the transport of goods by sea or inland waterway. According to the Incoterms 2020 rules, FOB defines the point at which the seller completes their delivery obligation to the buyer. Delivery is considered complete when the goods are physically loaded onto the vessel nominated by the buyer at the named port of shipment. The seller’s responsibility ends once the goods are secured on the ship, meaning the goods are “free” of the seller’s control and responsibility at that precise point.
FOB is limited to non-containerized bulk or break-bulk cargo, since the seller must be able to physically place the goods on board the vessel. While it is sometimes used incorrectly for containerized freight, the ICC recommends the Free Carrier (FCA) rule for container shipments. The FOB term functions as the baseline price for the goods, including all costs incurred to prepare and deliver the shipment to the departure vessel.
Seller and Buyer Obligations Under FOB
Under the FOB term, the seller is responsible for managing and paying for all aspects of the shipment up to the point of loading the goods onto the vessel. This obligation includes the costs of packaging, performing quality checks, and transporting the goods to the named port of shipment. The seller must also secure all necessary export licenses, handle customs formalities for exporting the cargo, and pay any duties or taxes associated with the export process. The seller’s financial commitment ceases the moment the cargo is successfully stowed on the buyer’s carrier at the agreed-upon port.
The buyer assumes all responsibilities and costs from the moment the goods are loaded onto the ship. This includes contracting and paying for the main carriage (ocean freight) to transport the goods from the port of origin to the destination port. The buyer is also responsible for all costs incurred during transit, such as marine insurance, and for the entire import process upon arrival. This subsequent financial burden encompasses:
- Unloading costs
- Import customs clearance
- Payment of duties and taxes
- Arranging the final delivery to the buyer’s premises
The Point of Risk Transfer
The delineation of risk transfer is a separate and significant aspect of the FOB Incoterm, distinct from the payment of costs. Under the Incoterms rules, the risk of loss or damage shifts from the seller to the buyer when the goods are placed on board the vessel at the port of shipment. This moment of transfer is definitive, legally separating the seller’s liability from the buyer’s.
If the cargo is damaged while being loaded, the seller remains liable because the risk has not yet passed. Conversely, if damage occurs during the ocean voyage, the buyer bears the responsibility for the loss. This transfer of liability is why a buyer often purchases marine cargo insurance, ensuring financial protection once their liability begins at the port of origin. The buyer assumes this risk even if they have not yet paid the seller for the goods.
Calculating the Total Landed Cost
The FOB price quoted by the seller represents only a portion of the total expense the buyer will ultimately incur for the transaction. The FOB cost includes the price of the goods plus the costs associated with preparing the cargo and delivering it to the ship. To arrive at the final expense, known as the Total Landed Cost, the buyer must add several major financial components to the initial FOB value. The Landed Cost provides a complete view of the actual expense required to get the product from the supplier’s location to the buyer’s final destination.
The largest addition to the FOB price is typically the cost of the main carriage, which is the ocean freight charge for transporting the goods across the sea. The buyer must also account for the cost of marine insurance to cover the risk assumed once the goods are loaded. Various terminal handling charges at both the origin and destination ports must also be factored in, including fees for documentation and moving the cargo within the port facility.
Upon arrival, the buyer must pay for all import-related costs, including customs duties, tariffs, and value-added taxes levied by the government. The final component involves the cost of inland transport, which is the expense of moving the cleared cargo from the destination port to the buyer’s facility.
Distinguishing International FOB from Domestic Terms
A frequent source of confusion, particularly for businesses in North America, is the difference between the international Incoterm FOB and older, domestic US shipping terms. In the international context, the Incoterm FOB is strictly defined for sea transport and specifies both cost and risk transfer upon loading the goods onto the vessel. This definition is standardized globally and carries legal weight in international commerce.
In contrast, terms like “FOB Origin” or “FOB Destination,” often found in domestic US purchase orders, are primarily used to indicate which party pays the freight bill. These domestic terms typically do not carry the same precise and legally binding provisions for risk transfer as the globally recognized Incoterm FOB. When engaging in international trade, businesses must understand that only the Incoterms rules apply to the contract, and the domestic usage of the term should be discarded to avoid contractual disputes.
Strategic Reasons to Use FOB
Choosing the FOB Incoterm provides strategic advantages for both the buyer and the seller over other arrangements like Cost, Insurance, and Freight (CIF) or Ex Works (EXW).
Advantages for the Buyer
Selecting FOB allows for greater direct control over the main carriage contract, enabling the buyer to negotiate freight rates with their preferred carrier or consolidator. This control often leads to lower freight costs and more predictable transit schedules. By managing the shipping, the buyer also gains visibility into the logistics chain, potentially avoiding markups that a seller might add when arranging the freight.
Advantages for the Seller
Using FOB limits the seller’s liability and logistical involvement to the early stages of the supply chain. Once the goods are loaded onto the vessel, the seller’s obligations are complete, freeing them from the complexities and financial risks associated with international transit and customs clearance in the buyer’s country. This arrangement simplifies the seller’s operation, allowing them to focus on production and timely delivery to the port.