Cummins Fights FUD with Warranties:

"Cat, like other engine manufacturers, used EGR successfully for many years. When it became clear that cooled-EGR would not provide vehicle owners with the reliability and value as is expected from the industry leader, Cat broke away from the pack to develop a technology breakthrough -� a more environmentally favorable alternative -� ACERT. Instead of staying with cooled-EGR, Cat has chosen to deliver to the marketplace an engine technology that will meet customer expectations for performance, lowered operating cost and proven resale while maintaining our commitment to the environment."

The EPA certified the Cummins ISX engine in April, the ISB engine in August, and the ISM engine in September. Caterpillar and Detroit Diesel asked the U.S. District Court for the District of Columbia to delay the Oct. 1 deadline. That motion was rejected on Sept. 5, 2002, which the EPA gleefully reported on Sept. 6, complete with a statement from Administrator Christine Todd Whitman, who doesn't ordinarily bother to herald every little procedural victory. Meanwhile, the EPA approved Volvo's VED12 engine on Sept. 30, and it was in the trucks rolling off the assembly line in November. Detroit Diesel got its Series 50 and Series 60 engines certified on Oct. 14.

Delays in Certification

So where's Caterpillar? On Sept. 26 the company announced that the EPA didn't have enough time to certify its engines, but it "does not foresee any obstacles to full certification." However, the final certification of the C9 engine didn't occur until Jan. 17, and full production is scheduled to begin in the coming weeks.

In its year-end 2002 report, Caterpillar said external sales of its engines were down 5% year-over-year to $1.84 billion in the fourth quarter. Internal sales of engines to the machinery division were up 6.75% to $316 million in the quarter. The more revealing figure, however, is that engine sales in North America -- the only sector impacted by the EPA's deadline -- were down 17% sequentially, from $873 million in the third quarter to $728 million in the fourth quarter.

So connect the dots. Cummins takes an early lead with certifications. Caterpillar and Detroit Diesel tell the EPA they need more time, but they're denied. Caterpillar criticized EGR, and customers experience fear, uncertainty, and doubt. A cloud of worry surrounds 2002 EGR engine launches by Cummins, Volvo, and Detroit Diesel. Some say Caterpillar operated the cloud-making machine. And Caterpillar has nothing comparable to sell until early 2003. And then, what a surprise! Just in time for the first ACERT deliveries, the cloud lifts, the economy brightens, and everyone's sales increase late in the year. Can it be that simple?

Davis said she couldn't comment on the 3.6% figure cited by Goldman Sachs. However, she strongly disagreed with Shatney's prediction that it could go higher. "If you look at the past year, our warranty costs, as a percentage of sales, have actually been on the decline. I don't see this new product introduction negatively impacting that trend," she said.

Declining Warranty Costs

Indeed, in 2000, what the Cummins accountants call "product coverage costs" consumed 4.2% of sales, up from 3.7% in 1999. The year before, Cummins had initially budgeted 3.3%, but problems with the then-new ISC engine forced that allocation up to a whopping 4.5%. Cummins had to take a $92 million special charge in 1998, of which $78 million went directly into the depleted warranty fund ($43 million for basic and $35 million for extended warranty costs).

Lustgarten sees some value in the Cummins Uptime Guarantee, in the way it seems to give the customer more than before. After all, this is a technology change brought on by government regulation, he notes. And it's no secret that there's a reduction in miles per gallon, even if it's only a slight decrease. Still, the customer needs to get more of something, or else they're going to shop used. A better warranty is a step in that direction. "That's the cost of trying to stimulate the marketplace to accept the inevitable," he said, "particularly at a time when the tendency is to postpone..."

Stephen Latin-Kasper, director of market data and research at the National Truck Equipment Association in Farmington Hills MI, said it's hard to separate out the effect the EPA rules are having on truck sales, which were trending downwards anyway due to the weak economic conditions.

"I can't say there's a trend yet regarding these new engines," Latin-Kasper said. "I mean, people have to buy the new engines now whether they like them or not. I think that ultimately people are going to end up liking them, and as they become more accepted, more and more of them will be bought."

"A lot of people assume there are going to be bugs in any new product: software, medical equipment, trucks, whatever. I think that goes along with fear of change." He said in this case, fear of change means fear of breakdowns, so an even better warranty is needed to produce the same level of peace of mind as before.

End of the Decline?

Tom Freiwald, vice president of marketing at Detroit Diesel, a DaimlerChrysler subsidiary, said he thinks the whole Oct. 1 issue is old news at this point. "The whole industry saw a big downturn after Oct. 1st, and nobody was quite certain how long it would last," he said, "but we've brought people back to work and increased production several times this year, because demand is picking back up nicely."

Of the pre-deadline FUD, very few of the predicted calamities came to pass. About the only noticeable change in the new engines is a 5% drop in fuel economy, Freiwald said. "The fleets that have them have not had any difficulty with them," he said, although it's still early days. "Business is picking up nicely."

Cummins Northwest Inc. Anchorage, Alaska

Larry Fuller, service manager at the Anchorage branch of Cummins Northwest Inc., said the new EPA engines haven't yet made it up to Alaska. But he's been briefed by both Detroit Diesel and Cummins about what's on the way.

"They added exhaust gas recirculation, variable geometry turbochargers, and a couple of other odds and ends, and it increases the cost. It decreases the fuel mileage. You pay a penalty for this new engine," Fuller said.

Is he worried? Not a bit. Advance word from the lower 48 is that everything is just fine. Yes, the engines are different, but they're not radically different.

"The drivers notice a difference," he said. "With this variable geometry turbocharger, the engine makes boost pressure at times when you think that it wouldn't." It's as if the engine is predicting the imminent need for acceleration. "Then, when you get back into the throttle, it's ready to go. It's got the boost, and when you put the fuel to it, it won't leave a cloud of smoke. So to the drivers, that seems a little odd."