freight-on-board

Freight on Board

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Freight on Board (FOB) is a shipping term where the seller is responsible for transportation until a specified transfer point, at which the buyer takes ownership and bears the risk. It is commonly used in international trade, providing cost savings and risk allocation benefits while requiring proper logistics coordination and customs compliance.

Key Elements of Freight on Board (FOB)

Understanding Freight on Board (FOB) involves recognizing its key elements:

  • Origin and Destination: FOB specifies two locations: the point of origin (usually the seller’s location or a specified port) and the destination (the buyer’s location or another specified location).
  • Risk Transfer: FOB indicates the moment at which risk is transferred from the seller to the buyer. This typically occurs when the goods are loaded onto the transportation vessel.
  • Ownership Transfer: FOB also specifies when ownership of the goods changes hands. This can occur either at the point of origin (FOB Origin) or at the destination (FOB Destination).
  • Transportation Costs: FOB determines who is responsible for transportation costs. In FOB Origin, the buyer typically bears the shipping costs, while in FOB Destination, the seller often covers these expenses.
  • Delivery Obligations: FOB outlines the obligations of the seller and the buyer regarding the delivery of goods. This includes responsibilities for loading, unloading, and ensuring the goods are ready for transport.

Applications and Implications of Freight on Board (FOB)

FOB has applications and implications in various international trade and shipping scenarios:

  • International Trade: FOB is a vital term in international trade agreements. It helps determine the division of responsibilities and costs between the seller and the buyer, promoting clarity and efficiency in cross-border transactions.
  • Risk Management: FOB specifies when risk is transferred, allowing both parties to manage and insure the goods accordingly. It provides a clear point at which the buyer becomes responsible for any damage or loss during transportation.
  • Logistics and Transportation: Freight companies, logistics providers, and shipping companies use FOB terms to understand their roles and responsibilities in the shipment process.
  • Customs and Import Regulations: FOB affects customs duties and import regulations, as it determines the value of goods and when they are considered to have entered a particular country.

Case Studies and Variations of Freight on Board (FOB)

To illustrate the complexities and implications of Freight on Board (FOB), let’s explore a few case studies and variations:

1. FOB Origin vs. FOB Destination

The distinction between FOB Origin and FOB Destination is critical. In FOB Origin, the risk and ownership transfer occur at the point of origin (e.g., the seller’s warehouse). In FOB Destination, these transfers happen at the destination (e.g., the buyer’s facility). This choice can significantly impact who pays for transportation and who is responsible for any damage during transit.

2. Letter of Credit in FOB Transactions

In international trade, particularly when dealing with unknown or untrusted parties, letters of credit are often used in FOB transactions. A letter of credit ensures that the buyer has the necessary funds to cover the purchase, reducing financial risk for the seller.

3. FOB and Incoterms

Incoterms (International Commercial Terms) are standardized trade terms published by the International Chamber of Commerce (ICC). They include terms like FOB, CIF, and EXW, each specifying different aspects of a transaction. FOB is just one of the many Incoterms that help streamline international trade practices.

Key Points about Freight on Board (FOB):

  • Definition: Freight on Board (FOB) is a shipping term used in international trade where the seller is responsible for transporting goods until a specified transfer point, at which the buyer takes ownership and bears the risk.
  • Characteristics:
    • Point of Transfer: Responsibility shifts from seller to buyer at a specified location.
    • Shipping Costs: The seller covers transportation costs to the transfer point.
    • Risk Allocation: Risk of damage or loss transfers to the buyer at the transfer point.
  • Use Cases:
    • International Trade: FOB is commonly used in international trade transactions.
    • Manufacturing Supply Chain: Used for shipping raw materials to manufacturing facilities.
    • Exporting Goods: Goods are shipped from the seller’s location to a foreign buyer.
  • Examples:
    • FOB Shenzhen Port: Seller arranges and covers shipping costs to Shenzhen Port.
    • FOB Factory Gate: Responsibility transfers at the factory gate.
    • FOB Houston Warehouse: Goods delivered to a Houston Warehouse, buyer takes ownership.
  • Benefits:
    • Cost Savings: Seller controls shipping, potentially reducing costs for the buyer.
    • Risk Management: Risk of damage or loss shifts to the buyer at the transfer point.
    • Flexibility: Suitable for various transportation modes and distances.
  • Challenges:
    • Documentation: Proper documentation is required for international FOB shipments.
    • Logistics Coordination: Coordination needed between seller, carrier, and buyer.
    • Customs Compliance: Compliance with import/export regulations and customs duties is essential.

In Summary:

  • Freight on Board (FOB) is a shipping arrangement that allows the seller to bear the shipping costs and responsibility for goods until a specified transfer point.
  • At this point, ownership and risk are transferred to the buyer.
  • FOB is commonly used in international trade and manufacturing supply chains, offering benefits like cost savings and risk management.
  • However, it requires proper logistics coordination, documentation, and compliance with customs regulations.

Related Frameworks, Models, ConceptsDescriptionWhen to Apply
Freight on Board (FOB)– An international commercial term (Incoterm) used in shipping. – Indicates that the seller delivers goods on board a vessel designated by the buyer at the named port of shipment. – The risk of loss or damage to the goods passes from seller to buyer when the goods are on board the ship.– Ideal for transactions where the buyer wants control over the shipping process and costs from the point the goods are loaded onto the ship.
Cost, Insurance, and Freight (CIF)– Another Incoterm where the seller pays for the costs, insurance, and freight to bring the goods to the port of destination. – The risk transfers to the buyer once the goods are loaded on the shipping vessel.– Used when buyers prefer the seller to handle all shipping logistics until the goods arrive at the destination port.
Ex Works (EXW)– Indicates that the seller delivers when they place the goods at the disposal of the buyer at the seller’s premises or another named place (i.e., factory, warehouse). – The buyer bears all costs and risks involved in taking the goods from the seller’s location to the desired destination.– Suitable for buyers who want full control over the entire shipping process from the seller’s location.
Delivered Duty Paid (DDP)– The seller assumes all the responsibility, risk, and costs associated with transporting goods until the buyer receives them, including paying duties and taxes.– Useful when the buyer wants to receive the goods without dealing with customs and importation processes.
Free Carrier (FCA)– The seller delivers the goods, cleared for export, to the carrier selected by the buyer at the specified location. – The risk transfers to the buyer once the goods are handed over to the first carrier.– Effective when the buyer wishes to arrange for the main carriage and wants control after the goods have been cleared for export.
Carriage Paid To (CPT)– The seller pays for the freight to transport goods to a destination. – However, the risk is transferred to the buyer when the goods are handed to the first carrier.– Applied when the seller is responsible for getting goods to a destination but does not cover insurance during transportation.
Bill of Lading– A legal document issued by a carrier to a shipper, detailing the type, quantity, and destination of the goods being carried. – Serves as a shipment receipt when the carrier delivers the goods at the predetermined destination.– Necessary for all parties in the shipping industry to confirm and document the transfer of goods.
Containerization– The use of standard-sized containers for transporting goods. – Facilitates efficient handling and transportation across different modes of transport.– Best for transporting large quantities of goods over long distances, especially when multiple modes of transport are involved.
Logistics Management– The organizational practice of planning, implementing, and controlling the efficient flow and storage of goods, services, and related information from the point of origin to the point of consumption.– Crucial for businesses looking to optimize their supply chain and ensure timely delivery of products.
Supply Chain Management (SCM)– Manages the entire production flow of a good or service — from the raw components all the way to delivery of the final product to the consumer.– Essential for companies aiming to reduce costs and improve efficiency by managing all aspects of the supply chain.

Connected Business Concepts

Revenue Modeling

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Revenue model patterns are a way for companies to monetize their business models. A revenue model pattern is a crucial building block of a business model because it informs how the company will generate short-term financial resources to invest back into the business. Thus, the way a company makes money will also influence its overall business model.

Pricing Strategies

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A pricing strategy or model helps companies find the pricing formula in fit with their business models. Thus aligning the customer needs with the product type while trying to enable profitability for the company. A good pricing strategy aligns the customer with the company’s long term financial sustainability to build a solid business model.

Dynamic Pricing

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Price Sensitivity

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Price sensitivity can be explained using the price elasticity of demand, a concept in economics that measures the variation in product demand as the price of the product itself varies. In consumer behavior, price sensitivity describes and measures fluctuations in product demand as the price of that product changes.

Price Ceiling

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A price ceiling is a price control or limit on how high a price can be charged for a product, service, or commodity. Price ceilings are limits imposed on the price of a product, service, or commodity to protect consumers from prohibitively expensive items. These limits are usually imposed by the government but can also be set in the resale price maintenance (RPM) agreement between a product manufacturer and its distributors. 

Price Elasticity

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Price elasticity measures the responsiveness of the quantity demanded or supplied of a good to a change in its price. It can be described as elastic, where consumers are responsive to price changes, or inelastic, where consumers are less responsive to price changes. Price elasticity, therefore, is a measure of how consumers react to the price of products and services.

Economies of Scale

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In Economics, Economies of Scale is a theory for which, as companies grow, they gain cost advantages. More precisely, companies manage to benefit from these cost advantages as they grow, due to increased efficiency in production. Thus, as companies scale and increase production, a subsequent decrease in the costs associated with it will help the organization scale further.

Diseconomies of Scale

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In Economics, a Diseconomy of Scale happens when a company has grown so large that its costs per unit will start to increase. Thus, losing the benefits of scale. That can happen due to several factors arising as a company scales. From coordination issues to management inefficiencies and lack of proper communication flows.

Network Effects

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A network effect is a phenomenon in which as more people or users join a platform, the more the value of the service offered by the platform improves for those joining afterward.

Negative Network Effects

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In a negative network effect as the network grows in usage or scale, the value of the platform might shrink. In platform business models network effects help the platform become more valuable for the next user joining. In negative network effects (congestion or pollution) reduce the value of the platform for the next user joining. 

Other Pricing Examples

Premium Pricing

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The premium pricing strategy involves a company setting a price for its products that exceeds similar products offered by competitors.

Price Skimming

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Price skimming is primarily used to maximize profits when a new product or service is released. Price skimming is a product pricing strategy where a company charges the highest initial price a customer is willing to pay and then lowers the price over time.

Productized Services

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Productized services are services that are sold with clearly defined parameters and pricing. In short, that is about taking any product and transforming it into a service. This trend has been strong as the subscription-based economy developed.

Menu Costs

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Menu costs describe any cost that a business must absorb when it decides to change its prices. The term itself references restaurants that must incur the cost of reprinting their menus every time they want to increase the price of an item. In an economic context, menu costs are expenses that are incurred whenever a business decides to change its prices.

Price Floor

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A price floor is a control placed on a good, service, or commodity to stop its price from falling below a certain limit. Therefore, a price floor is the lowest legal price a good, service, or commodity can sell for in the market. One of the best-known examples of a price floor is the minimum wage, a control set by the government to ensure employees receive an income that affords them a basic standard of living.

Predatory Pricing

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Predatory pricing is the act of setting prices low to eliminate competition. Industry dominant firms use predatory pricing to undercut the prices of their competitors to the point where they are making a loss in the short term. Predatory prices help incumbents keep a monopolistic position, by forcing new entrants out of the market.

Price Ceiling

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A price ceiling is a price control or limit on how high a price can be charged for a product, service, or commodity. Price ceilings are limits imposed on the price of a product, service, or commodity to protect consumers from prohibitively expensive items. These limits are usually imposed by the government but can also be set in the resale price maintenance (RPM) agreement between a product manufacturer and its distributors. 

Bye-Now Effect

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The bye-now effect describes the tendency for consumers to think of the word “buy” when they read the word “bye”. In a study that tracked diners at a name-your-own-price restaurant, each diner was asked to read one of two phrases before ordering their meal. The first phrase, “so long”, resulted in diners paying an average of $32 per meal. But when diners recited the phrase “bye bye” before ordering, the average price per meal rose to $45.

Anchoring Effect

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The anchoring effect describes the human tendency to rely on an initial piece of information (the “anchor”) to make subsequent judgments or decisions. Price anchoring, then, is the process of establishing a price point that customers can reference when making a buying decision.

Pricing Setter

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A price maker is a player who sets the price, independently from what the market does. The price setter is the firm with the influence, market power, and differentiation to be able to set the price for the whole market, thus charging more and yet still driving substantial sales without losing market shares.

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