You're wheeling, you're dealing, you're buying inventory here, and receiving inventory from there. Then, the worst happens: A shipment is damaged or lost, and the finger-pointing begins about who's to blame and, more importantly, who's responsible for covering the costs to make things right.
Free on board (FOB) shipping clarifies predicaments like this by defining exactly when ownership of transported goods changes from one party to another. We'll go over FOB basics, its variations, and the benefits your small business can enjoy from using it.
Overview: What is FOB in shipping?
Otherwise, if a shipment is damaged or lost in transit, contentious, and expensive, legal wrangling could ensue to determine financial responsibility.
FOB benefits include:
- Defining the transaction between seller and buyer
- Identifying costs, responsibilities, risks, and tasks
- Specifying shipment logistics and transportation management
The two major FOB types are FOB shipping point and FOB destination, which we'll discuss in depth below.
FOB originally referred to overseas shipments by boat, but its use in the U.S. more generally applies to all forms of delivery transport, including truck, rail, and air.
Why is FOB important?
FOB not only identifies who's responsible at which points for shipping costs and liabilities, but it also impacts your total costs and accounting practices for each shipment.
FOB shipping point means you choose your delivery method, which can lower costs, or you can avoid liability, even though you'll likely pay more, with FOB destination. The point at which the goods' ownership transfers and related shipping costs also affect your cost of goods sold (COGS).
Free on board shipping vs. free on board destination: What's the difference?
Two differences distinguish FOB shipping point from FOB destination: which party pays for shipping and the point ownership of goods transfers from seller to buyer.
- FOB shipping point: Buyer pays for shipping and owns the goods once they ship.
- FOB destination: Seller pays for shipping and owns the goods until delivery.
Let's say you're in Dallas and purchase a bulk order of widgets from a San Francisco wholesaler. An "FOB San Francisco" shipment means you're responsible for shipping them from San Francisco to Dallas and own the goods when the shipping company picks them up.
An "FOB Dallas" shipment means the wholesaler will cover shipping costs and owns the goods until you receive them.
Other FOB options include:
- FOB shipping point, freight prepaid: The seller pays for shipping; the buyer assumes responsibility for goods at the point of origin.
- FOB shipping point, freight prepaid and charged back: The seller doesn't pay for shipping but adds that cost to the invoice sent to the buyer, who assumes responsibility for goods at the point of origin.
- FOB destination, freight prepaid and charged back: The seller pays for shipping, but the buyer deducts that cost from the original invoice, which includes the shipping paid for by the seller.
- FOB destination, freight collect: The buyer pays for shipping, but the seller owns goods in transit.
- FOB destination, freight collect and allowed: The seller adds shipping to the invoice, and the buyer pays that cost, but the seller assumes the responsibility for goods until delivery.
Each option has pros and cons, depending on your specific situation, as we'll discuss in the next section.
How free on board (FOB) works
When I was a book publisher, we printed our four-color books in China. Our printer was responsible for shipping books from China to San Diego, but then we had a choice: FOB shipping point or FOB destination to get them to our book distributor's warehouse in Little Rock, Arkansas.
FOB shipping point might let us find rates cheaper than our printer charged. We were a small shop in Texas, however, so we weren't in Southern California to deal with U.S. customs and had no expertise in that area.
We also didn't want to be liable if something happened to our books while they were en route to Arkansas. So, even though it was more expensive, we went with FOB destination.
We always needed, however, one pallet of books shipped to our offices for direct sales and marketing purposes. The FOB destination terms included the stipulation that the printer delivered to one address and having them split the order in San Diego was a significant extra expense for us.
Instead, it was more cost-effective to ship all the books to Little Rock and have our distributor send a pallet of books to us from there.
Is free on board shipping (FOB) right for your business?
If you're buying products in bulk shipped to your business or warehouse, you're already using the FOB options your wholesale distributors have chosen. As a small business owner, you want to make your own decisions, and with FOB shipping point, it's a matter of finding the right balance between reward and risk.
FOB shipment rewards
FOB shipping point rewards boil down to one thing: control. You decide who ships your goods based on price or other factors, you own the goods when they're on their way to you, and you can schedule shipments to one or more warehouses to meet your inventory management needs.
If you use inventory management software, track each FOB delivery online to keep a close eye on it from departure to arrival.
FOB shipment risks
The risks relate to your tolerance for liability. Can you handle the logistics of shipping as well — or better — than your supplier? Are there in-transit security issues you don't want to be responsible for?
Do you have enough slack built into your inventory control processes to tolerate a lost or delayed shipment? If you know the risks and aren't willing to bear them, FOB shipping point may not be your best option.
Don't get me wrong: Choosing your own logistics or transport company for shipping will likely be cheaper and get your goods safely to you. But, like every other vendor you use, do the research necessary — different shipping options, costs, terms, and suppliers — to make an informed choice.
Let FOB shipping work for you
FOB illustrates the tension between control and liability. Sure, you want to keep costs low by making your own shipping arrangements, but can you afford the liability if something goes wrong? Know your FOB options, so you can make the best decision based on each situation.