Making the Case for Quality
Cummins Capitalizes on Six Sigma to
Minimize Long-Term Interest Rate Risk
Groundbreaking Use of Six Sigma in Capital Markets
At a Glance . . .
• Cummins Inc., a leading
manufacturer of diesel
engines, utilizes Six Sigma
in virtually every facet of its
worldwide operations,
saving nearly $1 billion in
six years.
• Employees in Cummins’
treasury department, a
nontraditional area for Six
Sigma, have embraced Six
Sigma, using it to make a
recommendation to
optimize the company’s
ratio of fixed- to floating-
rate debt.
• A Green Belt project
employing the DMAIC
process resulted in an
interest rate swap that
saves Cummins $1 million
annually through a long-
term risk reduction strategy.
The American Society for Quality ■ www.asq.org
by Janet Jacobsen
When Cummins Inc. took a leap of faith nearly six years ago in labeling Six Sigma as the process
improvement methodology for the company, top leadership meant the entire company, not just the
engineering departments and the shop floors where their renowned diesel engines are produced. At
Cummins, the scope of Six Sigma extends well beyond typical manufacturing operations—it branches
from the legal department to manufacturing to human resources and even to the treasury department,
where innovative employees are saving the company millions of dollars by conducting Six Sigma
projects to reduce earnings volatility and to lower interest rate expenses.
About Cummins Inc.
Established in 1919, Cummins is a global power leader that designs, manufactures, sells, and services
diesel engines and related technology. Cummins serves its customers through a network of 550
company-owned and independent distributor facilities and 5,000 dealer locations in more than 160
countries and territories. The company enjoyed its most profitable year in 2005, earning $550 million
on sales of nearly $10 billion, due in part to its far-reaching Six Sigma initiative.
To date, Cummins has:
• More than 5,000 Six Sigma projects completed, resulting in nearly $1 billion in savings,
• 3,700 employees who have taken Six Sigma training,
• 500 Black Belts, and
• 65 Master Black Belts.
Can Six Sigma Improve Treasury Processes?
The treasury department at Cummins’ Columbus, Indiana, headquarters is divided into two segments:
cash management and capital markets. Within the capital markets group, three employees serve two
primary functions: corporate finance and risk management, which include managing the interest rates
on the company’s debt.
Until recently, virtually 100% of Cummins’ debt was at a fixed interest rate rather than a floating rate.
Historically, floating-rate debt is less expensive than fixed, so a change to the company’s financial strat-
egy by shifting some of the debt to a floating rate provided a potential opportunity to minimize
earnings volatility.
Page 1 of 4
 While a few previous attempts were made to “swap” interest
rates when rates were low, these were short-term tactics con-
ducted with a specific savings goal in mind rather than as a
longer-term risk reduction strategy—until Cummins sent Craig
S. Moore, a new employee in the treasury department, to the
company’s Six Sigma training program.
Moore, now the manager of the capital markets group in the
treasury department, was anxious to begin the four, one-week
internal Six Sigma training sessions after studying former
General Electric (GE) CEO
Jack Welch’s writings, which
detailed GE’s success with
Six Sigma. Early in the train-
For an overview of Six Sigma at ing Moore began to envision
Cummins, see the case study “Six
using Six Sigma tools to
Sigma Saves Nearly $1 Billion, Key
devise a recommendation
Customers, and a Company.”
on the company’s fixed- to
floating-rate debt ratio.
“Part of our goal tree for our department was to reduce risk,
which fits with our company mission to grow profitable, stable
earnings. This (Six Sigma project) was one way for treasury to
contribute to that initiative by reducing risk and helping to
reduce variability in our business results,” Moore explains.
Utilizing the DMAIC Process to Reduce Financial Risk
Moore, with his sponsor, Dean Cantrell, embarked on the
Fixed/Floating Strategy Green Belt Six Sigma project in
December 2004, following the define, measure, analyze,
improve, and control (DMAIC) process that is widely used
throughout Cummins’ worldwide Six Sigma initiative.
Moore’s ultimate goal was to execute an interest rate swap on
a company debt instrument (which mirrored a long-term bond
that was issued by Cummins) utilizing Six Sigma tools. He
viewed this rate swap not as merely a savings tool, but rather
as a risk-reducing strategy that would become part of
Cummins’ capital framework.
His first step was to define the opportunity, which in this case
was finding the right percentage of floating-rate debt for the
company’s balance sheet. “No one had ever done that analysis
before to say what is the right percentage. Zero wasn’t correct,
but no one knew the right amount,” Moore recalls.
The measurement phase for this project was a very straightfor-
ward process, according to Moore. He merely validated the
current interest rate status, which showed that an overwhelming
majority of the debt was at a fixed rate. This step also included
reviewing debt on and off the balance sheet to confirm that a
majority of Cummins’ debt was at a fixed interest rate.
It was during the analyze and improve stages that Moore, a
finance expert who was new to quality tools before joining
Cummins, was ultimately able to use some of the tools he’d stud-
ied during his belt training. “I finally realized that I didn’t have
to use all of the tools in the Six Sigma bag; the objective was the
The American Society for Quality ■ www.asq.org
DMAIC steps. Once I realized that I didn’t have to use every
tool, only those that applied to my project, Six Sigma became
easier,” he notes.
In addition to process mapping and cause-and-effects matrices,
Moore used the following tools for his groundbreaking Six
Sigma project:
• Failure mode and effects analysis (FMEA)
• Multi-vari studies
• Monte Carlo simulation
FMEA
Moore conducted an FMEA to detect potential obstacles that
could develop during the interest rate swap transaction. He
reports that one key issue identified during this analysis was the
possibility of not receiving the desired short-cut accounting treat-
ment: He didn’t want the accounting staff to be required to
document effectiveness each quarter on this transaction because
it is such a tedious process.
By identifying this issue before setting up negotiations with
financial institutions to carry out the transaction, Moore was able
to work through this potential obstacle up front and thus save
time and money down the road. “This was an area where Six
Sigma was very useful as we were able to identify key issues and
work through them with our accountants ahead of time. We had
everyone on board with the proper accounting before we even
began talking to banks,” notes Moore.
Multi-Vari Analysis
Moore also ran a regression analysis of Cummins’ earnings to
interest rate cycles. As shown in Figure 1, a high correlation
existed between earnings and interest rates. He notes that during
times of higher earnings the company should theoretically be
able to support higher interest rates; and conversely during
slower economic times, the Federal Reserve typically lowers
interest rates. “What this correlation told us was that it doesn’t
make sense to have 100% fixed rates,” recalls Moore.
In another multi-vari analysis Moore studied historical interest
rate cycles as depicted in Figure 2. Here the forward curve or the
orange line shows where interest rate traders predict that interest
rates will stand in two to three years or more. The blue line rep-
resents actual interest rates under the London Interbank Offer
Rate (LIBOR). As the chart indicates, interest rate traders nor-
mally overpredict where interest rates will be by approximately
75 basis points. “If they say interest rates are going to be 6% in
the future, it actually is more likely to be 5.25%, so there’s
opportunity there to generate some savings,” says Moore.
Monte Carlo Simulation
The multi-vari studies determined a strong rationale for having a
floating-rate debt, but the next obvious question was, How much
floating-rate debt should Cummins have on the balance sheet?
Page 2 of 4
 Thus a Monte Carlo simulation was conducted with hundreds of Figure 2 Historical Floating/Forward Rate Analysis
different interest rate scenarios to chart interest expenses on a
“y” axis and volatility on an “x” axis. Historical Forward 3m London Interbank Offer Rates

11.0%
This analysis determined the optimal fixed- to floating-rate ratio
for Cummins by creating an efficient frontier curve as shown in 10.0% 3m forward curve (orange lines)
Figure 3. “On this curve, you minimize the average volatility and
9.0%
your interest rate expense when you are roughly between a 30%
to 40% floating rate. This is how we were able to determine the 8.0%
right percentage for Cummins,” explains Moore.
7.0%

Of course the final step in the DMAIC process focuses on con-

Yield
6.0%
trolling or sustaining the gains that were achieved. Moore says
that he was able to put a control plan in place by looking back at 5.0%

the results of the FMEA. Cummins was extraordinarily prepared 4.0%

before negotiating with banks and was quite specific about how
it wanted to complete the deal because the potential failures were 3.0%
addressed in detail ahead of time. 3m LIBOR spot (blue line)
2.0%

The long-term control plan now involves a quarterly review of 1.0%

the balance sheet to review the fixed- to floating-rate ratio and Jan-88 Oct-91 Jul-95 Apr-99 Jan-03 Oct-06 Jul-10
ensure that Cummins’ finances remain in the target range as The forward curve generally overpredicts where London Interbank Offer Rate (LIBOR)
determined by the analysis for this project. actually sets interest rates.

Figure 1 Cummins’ Earnings Before Interest/Interest

Rate Correlation Figure 3 Fixed/Floating Rates Achieve Risk
Earnings Before Interest (EBIT) Versus London Interbank Offer Rate (LIBOR)
Diversification
One-year LIBOR (bps)
EBIT (USD mm)

LIBOR EBIT The efficient frontier demonstrates that combining fixed and floating
1,000 600
Financial year end debt can reduce interest expense volatility as well as cost.
400
500 • The fixed-floating “efficient frontier” is a graphical representation of
200
the tradeoff between the interest expense and volatility of a mixed
0 0
portfolio of fixed- and floating-rate debt.
1992

1993

1994

1995

1996

1998

1999

2000

2001

2002

2003
1997

• A portfolio of 100% fixed-rate debt has the highest cost, while a portfolio
Observations of 100% floating-rate debt has the lowest cost and highest volatility.
• Cummins’ earnings before interest (EBIT) versus interest rates: • However, the relationship is not straight-line, as overall volatility is
• EBIT and average one-year London Interbank Offer Rate (LIBOR) reduced by combining two instruments that are not perfectly correlated.
have shown a positive correlation over the past business cycle. • The tradeoff between fixed and floating is therefore one of interest
• 1992–2003: r2 = 0.84 cost versus interest expense certainty.

Change in EBIT Versus % Change in LIBOR 7.5%

100% Fixed Current portfolio
Annual percentage change

80% % change in LIBOR Change in EBIT 100% 7.3% 0%

60% 10%
in one year LIBOR

Financial year end 50% 7.1% Target portfolio

40% 20%
EBIT change

20% 6.9% 30%

Interest expense

0% 0% Minimum risk:
6.7% 40% 40% floating
(20)% (50)% 50%
(40)% 6.5%
(60)% 60%
(100)%
(80)% *based on lognormal changes 6.3% 70%
(100)% (150)% 6.1% Higher 80%
1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

cost 90%
5.9%
100%
5.7% Higher risk
Observations 100% Floating
• Cummins’ change in EBIT versus change in interest rates: 5.5%
4% 6% 8% 10% 12% 14% 16% 18% 20%
• LIBOR levels have been very low compared with the historical trends Average volatility
since 1992.
• Correlation between annual percentage change in interest rates and EBIT: Rates since 1968: U.S. 3m T-Bills vs. 10-year bonds.
• 1992–2003: r2 = 0.48 Assumes 10% of portfolio is refinanced every year.

The American Society for Quality ■ www.asq.org Page 3 of 4

 Rate Swap Saves Money, Reduces Risk Contributing to This Article

Once the project received approval from the Cummins’ board of
directors in spring 2005, financial market conditions were such
that a brief hold was placed on the execution of the interest rate
swap until the market shifted back to a desired point. Ultimately
the rate swap was completed in late 2005, shifting approximately
30% of Cummins debt to a floating rate of interest.
According to Moore, the company will save an average of more
than $1 million per year until the debt instrument’s maturity date.
He calculates this savings based on the average interest rate in the
last 15 years versus the Cummins’ interest rate for this transaction.
Craig S. Moore is manager of the capital markets group in
Cummins’ treasury department. A certified treasury professional,
Moore earned his MBA from DePaul University. Moore is a Six
Sigma Green Belt and has participated in 11 Six Sigma projects
at Cummins in his two years with the company.
About the Author
Janet Jacobsen is a freelance writer specializing in quality and
compliance topics. A graduate of Drake University, she resides
in Cedar Rapids, Iowa.

Moore says that these results met company expectations and

accomplished the project’s goals. “The results were substantial
and one of the best things to come out of this was a risk-reducing
strategy, which fits within our overall mission,” he notes.

Jump Start for Future Projects

Moore credits the fixed/floating rate project for putting a positive

spin on Six Sigma in a nontraditional setting. “It broke through
the mental barrier people have in thinking Six Sigma is only for
manufacturing and doesn’t apply to nonmanufacturing roles like
treasury,” he says.

Now on his sixth Green Belt project, Moore sees growing

acceptance for Six Sigma in the finance area. He reports that the
cash operations area has really taken Six Sigma to the next level
and they have a hopper of Six Sigma projects with at least 16
potential ideas.

“We’ve really adopted Six Sigma and it is now a part of the

DNA of the treasury department. Once we successfully com-
pleted the first project, people then realized how it could apply to
them and improve decision making in addition to building
stronger processes and controls,” states Moore.

For More Information

• To learn more about Cummins’ groundbreaking fixed/floating

interest rate Six Sigma project, contact Green Belt Craig
Moore via e-mail at craig.s.moore@cummins.com.
• For more information about Cummins Inc., visit the com-
pany’s Web site at www.cummins.com.
• Read the companion case studies to this piece:
• Six Sigma Saves Nearly $1 Billion, Key Customers, and
a Company
• Cummins Six Sigma Project Results in a Smoother Ride
for Dodge Ram Pickup

The American Society for Quality ■ www.asq.org Page 4 of 4