Free on Board (FOB) is a shipment term that defines the point in the supply chain when a buyer or seller becomes liable for the goods transported. Purchase orders between buyers and sellers set FOB terms and help determine ownership, risk, and transportation costs.
This centuries-old shipping term has evolved into a critical concept of determining the reliability and ownership transfer. The internationalization of markets and technological progress in logistics, distribution, and communication means this affects almost every product consumers buy.
By specifying whether goods are shipped FOB Origin or FOB Destination, companies clearly define where and when they bear the costs and risks associated with transportation. This not only impacts prices and how and when goods are transported but also has significant implications for insurance, customs duties, and legal disputes.
Key Takeaways
- Free on Board (FOB) indicates when the ownership of goods transfers from buyer to seller and who is liable for goods damaged or destroyed during shipping.
- FOB Origin means the buyer assumes all risk once the seller ships the product.
- FOB Destination means the seller retains the risk of loss until the goods reach the buyer.
- FOB terms impact inventory, shipping, and insurance costs.
Xiaojie Liu / Investopedia
Understanding FOB Shipping
FOB is a widely used shipping term that applies to both domestic and international transactions. It’s an agreement between the buyer and seller that specifies when the ownership and liability for the goods being shipped transfer from the seller to the buyer. FOB terms are typically included in shipping orders and contracts, detailing the time and place of delivery, payment terms, and which party handles freight costs and insurance.
FOB conditions are defined in the purchase order between the vendor and the client. While FOB status doesn’t determine ownership (which is in the bill of sale or separate agreement), it does say which party assumes responsibility for the shipment at different points in the journey. The two main types of FOB are:
- FOB Origin: The buyer takes responsibility for the goods as soon as they leave the seller’s location. The buyer bears the costs and risks associated with transportation from that point forward.
- FOB Destination: The seller retains responsibility for the goods until they reach the buyer’s destination. The seller bears the costs and risks associated with transportation up to that point.
Whether the transaction is domestic or international, FOB conditions influence inventory management, shipping costs, and insurance requirements. This is especially important for shippers to watch as costs have risen and fallen sharply in recent years:
FOB Origin vs. FOB Destination
The most common international trade terms are Incoterms, which the International Chamber of Commerce publishes, though firms that ship goods within the U.S. must adhere to the Uniform Commercial Code.
Since there is more than one set of rules and legal definitions of FOB, which may differ from one country to another, the parties to a contract must indicate which governing laws are being used for a shipment.
| Characteristics | FOB Origin | FOB Destination |
|---|---|---|
| Transportation Costs | The buyer handles transportation costs from the seller’s location to the final destination. | The seller handles transportation costs until the goods reach the buyer’s destination. |
| Risk of Loss or Damage | The risk of loss or damage to the goods transfers to the buyer once the goods leave the seller’s location. | The risk of loss or damage remains with the seller until the goods reach the buyer’s destination. |
| Shipping Arrangements | The buyer handles shipping and handling from the seller’s location to the final destination. | The seller handles arranging shipping and handling until the goods reach the buyer’s destination. |
| Insurance | The buyer typically arranges and pays for insurance. | The seller generally arranges and pays for insurance. |
| Customs and Import Duties (International) | The buyer is responsible for customs clearance and paying import duties and taxes. | The seller is responsible for customs clearance and paying import duties and taxes. |
| Price | The price of the goods is typically lower since it doesn’t include transportation costs beyond the seller’s location. | The price of the goods is generally higher since it includes transportation costs up to the buyer’s destination. |
| When Typically Used | Often used for domestic shipments or when the buyer has control over shipping preferences. | Often used for international shipments or when the seller wants to offer a more inclusive service. |
FOB Advantages and Disadvantages
Benefits of FOB Origin
For buyers, FOB Origin can be more cost-effective because they can choose their freight forwarder and manage freight costs more effectively. In addition, buyers have more control over the shipping process and this allows them to manage logistics and mitigate issues more effectively. Here are further advantages for both the buyer and seller:
| Benefits | Buyers | Sellers |
| Cost Control | Control over shipping, select carriers/routes to meet budget and timeline, and potentially cut costs. | Transfer shipping costs and responsibilities to the buyer, simplify pricing, and focus on core business. |
| Risk Management | Assume risk of loss or damage from origin; choose insurance providers and coverage levels. | Limit liability for goods during transit, fewer claims/disputes over damaged or lost goods. |
| Operations | Can streamline supply chain, and coordinate directly with carriers for timely deliveries. | Reduces complexity of shipping logistics, faster turnaround times, and focus on production. |
| Flexibility | Negotiate shipping terms and costs with carriers directly. | Transfer goods at the point of origin without navigating international shipping regulations. |
Disadvantages of FOB Origin
For FOB Origin, the buyer assumes all risks related to damage, destruction, and loss during transit once the goods are loaded onto the chosen mode of transport at the origin point. This arrangement can be more expensive for the buyer, particularly if the shipment is large or travels a long distance. Resolving any issues that arise during transportation can also be time-consuming for the buyer.
Another disadvantage of FOB Origin is that the buyer is wholly responsible for arranging and managing transportation. This responsibility includes tasks such as finding a suitable carrier, negotiating rates, handling export documentation, and covering additional expenses like insurance, customs clearance, and other logistical services.
FOB Origin also presents risks for sellers. Since the quoted price typically excludes transportation and insurance costs, the final landed cost for the buyer can often be higher than FOB Destination. This can make the seller’s offer less competitive and potentially impact sales volume.
To mitigate these risks, buyers should carefully consider their ability to manage transportation and associated costs before agreeing to FOB Origin terms. It’s essential for both parties to have a clear understanding of their responsibilities and to maintain open communication throughout the shipping process.
Benefits of FOB Destination
For sellers, FOB Destination allows them to improve their customer service by taking responsibility for the goods until delivery, what this does is to improve customer satisfaction and loyalty. In addition, buyers do not assume ownership until the goods are delivered, which allows them to inspect the goods before accepting them. Here are further advantages:
| Benefits | Buyers | Sellers |
| Cost Control | No upfront shipping costs; shipping costs are included in the purchase price. | Control shipping costs, allowing for potential bulk rate negotiations with carriers. |
| Risk Management | The risk of loss or damage remains with the seller until the goods arrive at the destination, reducing the buyer’s risk. | Maintain responsibility for goods during transit. |
| Operations | Simplified logistics as the seller handles shipping arrangements; reduces the buyer’s administrative tasks. | Potentially streamline shipping and delivery, potentially leading to quicker resolution of transit issues. |
| Convenience | Simplified purchasing process with fewer logistical concerns; goods are delivered directly to the buyer’s location. | Could improve customer satisfaction by providing end-to-end service. |
| Customer Service | Sellers often have better customer service and support and can handle any issues that arise during shipping. | Establish more robust relationships with buyers through the broad provision of services. |
Risks and Disadvantages of FOB Destination
In this arrangement, the seller retains liability for the goods until they are delivered to the buyer. This means the seller bears the risk of loss, damage, or destruction during transit, which can impact their reputation and profitability. If any issues arise during shipping, the seller handles resolving them and may need to replace or refund the damaged goods.
In addition, sellers are typically responsible for freight charges, which adds to their overall costs. To account for these expenses, sellers may need to increase the final price for the buyer. This can affect the seller’s competitiveness in the market, as buyers may opt for lower-priced alternatives.
Another disadvantage for sellers is that they may not be able to record the sale until the goods are delivered to the buyer. This can affect their accounting processes and cash flow since there may be a delay between shipping the goods and receiving payment.
Furthermore, once the goods leave the port of origin, the seller has limited control over the shipment and may face delays during transit. This can raise questions about their ability to meet delivery deadlines and is a significant risk for FOB Destination transactions. Sellers should have contingency plans to manage potential delays and communicate effectively with buyers in such situations.
To mitigate these risks, sellers should consider their ability to absorb potential losses and manage shipping costs before agreeing to FOB Destination terms. Both parties must clearly understand their responsibilities and maintain open communication throughout the shipping process to address any issues that may arise.
FOB and Company Accounting
For FOB Origin, after the goods are placed with a carrier for transport, the company records an increase in its inventory and the seller records the sale. For FOB Destination the seller completes the sale in its records once the goods arrive at their final destination, and the buyer records the increase in its inventory at that time.
Free on Board Example
Suppose the manager of Dara Inc. in New York City orders 1000 units of electronic components from ABC Co. in Shanghai, China. The contract specifies FOB Origin for the shipment. However, the managers of Dara Inc. want to know what the difference would be if they opted for FOB Destination. Let’s set those out:
FOB Origin Example
Seller’s Responsibilities:
- ABC Co. prepares the electronic components for shipment.
- It loads the goods onto a shipping vessel at the port of origin in Shanghai.
- The seller’s responsibility ends when the goods are placed with the carrier.
Buyer’s Responsibilities:
- Dara Inc. assumes ownership of the goods as soon as they are loaded onto the vessel.
- It’s responsible for ensuring the goods reach their final destination in New York City.
- Dara Inc. pays for all costs associated with shipping the goods, including freight, insurance, and customs clearance.
FOB Destination Example
Seller’s Responsibilities:
- ABC Co. prepares the electronic components for shipment.
- It loads the goods onto a shipping vessel at the port of origin in Shanghai.
- The seller retains ownership and liability for the goods until they reach the buyer’s destination in New York City.
Buyer’s Responsibilities:
- Dara Inc. doesn’t assume ownership until the goods are delivered to their warehouse in New York City.
- It inspects the goods upon arrival and reports any damages or issues.
- Dara Inc. pays for all shipping costs, including freight, insurance, and customs.
The choice between FOB Origin and FOB destination depends on the specific needs of both parties. Since Dara Inc. has experience managing international shipping or wants to save on transport costs, FOB Origin, they decided to go forward this way. However, if the seller wants to minimize risk and offer a complete service (including delivery), FOB Destination would be a better option.
Additional Shipping Terms
Here are further prominent terms you’ll see when reviewing shipping responsibilities:
| Term | Acronym | Meaning | Mode(s) |
| Bill of Lading | B/L | A legal document between the shipper and the carrier detailing the type, quantity, and destination of goods. | All modes |
| Carriage and Insurance Paid To | CIP | The seller pays for carriage and insurance to the named destination. Risk transfers to the buyer when the goods have been handed over to the carrier. | All modes |
| Carriage Paid To | CPT | The seller pays for carriage to the named destination. Risk transfers to the buyer when the goods have been handed over to the carrier. | All modes |
| Cost and Freight | CFR | The seller pays for the cost and freight to bring the goods to the destination port. The risk transfers to the buyer once the goods are on the ship. | Sea and inland waterways |
| Cost, Insurance, Freight | CIF | The seller covers the cost, insurance, and freight to bring the goods to the destination port. The buyer assumes risk once the goods are loaded onto the vessel. | Sea and inland waterways |
| Delivered at Frontier | DAF | Requires a seller to deliver goods to a border location. The seller is usually responsible for all costs of transporting the goods to the drop-off point for the buyer. The party picking up the goods will usually be importing them and traveling across customs. | All modes |
| Delivered at Place | DAP | The seller delivers the goods to a named place (usually the buyer’s premises), and the buyer handles import duties and taxes. The risk transfers when the goods are made available for unloading. | All modes |
| Delivered at Terminal | DAT | The seller delivers the goods to a terminal at the destination port or place, and the buyer handles import duties, taxes, and further transport. The risk transfers when the goods are unloaded at the terminal. | All modes |
| Delivered Duty Paid | DDP | The seller handles the delivery of the goods to the named place in the buyer’s country and covers all costs, including duties. | All modes |
| Ex Works | EXW | Sellers make goods available at their premises. The buyer handles all transport and risks from that point on. | All modes |
| Free Alongside Ship | FAS | The seller is obligated to deliver goods to an airport, shipping port, or railway terminal where the buyer has an established place of operation and takes delivery there. | Sea and inland waterways |
| Free Carrier | FCA | The seller is obligated to deliver goods to an airport, shipping port, or railway terminal where the buyer has an established place of operation and takes delivery there. | All, but typically used for land, sea/inland waterways, and air transport |
| Freight on Board | FOB | Same as Free on Board. | Sea and inland waterways |
| Full Truckload | FTL | A shipment that fills an entire truck. | Road |
| Less Than Truckload | LTL | A shipment that doesn’t fill an entire truck. | Road |
What Is FOB Pricing?
The costs associated with FOB can include transportation of the goods to the port of shipment, loading the goods onto the shipping vessel, freight transport, insurance, and unloading and transporting the goods from the arrival port to the final destination.
Who Pays Freight for FOB Origin?
If the terms include the phrase “FOB Origin, freight collect,” the buyer handles freight charges. If the terms include “FOB Origin, freight prepaid,” the buyer assumes responsibility for goods at the point of origin, but the seller pays the cost of shipping.
What Is the Difference Between FOB and CIF?
CIF (Cost, Insurance, and Freight) and FOB (Free on Board) are two widely used Incoterm agreements. Although the definition of both terms can differ across countries and is ultimately determined by each vendor-client contract, historically, FOB transfers liability from seller to buyer when the shipment reaches the port or other facility designated as the point of origin. With a CIF agreement, the seller pays costs and assumes liability until the goods reach the port of destination chosen by the buyer.
The Bottom Line
Understanding Free on Board (FOB) is crucial for businesses engaged in domestic and international trade. FOB Origin and FOB Destination each come with their own set of responsibilities, costs, and risks for buyers and sellers. By clearly defining these terms in their contracts and agreements, parties can help ensure a smooth transfer of goods and minimize the potential for disputes.
Ultimately, the choice between FOB Origin and FOB Destination depends on various factors, including the nature of the goods, the distance they must travel, and the buyer’s and seller’s ability to manage transportation and associated risks. Businesses should carefully assess their options and negotiate terms that fit their needs.