1. The American Society for Quality ■ www.asq.org Page 1 of 4
Making the Case for Quality
• 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.
At a Glance . . .
Cummins Capitalizes on Six Sigma to
Minimize Long-Term Interest Rate Risk
Groundbreaking Use of Six Sigma in Capital Markets
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.
by Janet Jacobsen

2. 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-
ing Moore began to envision
using Six Sigma tools to
devise a recommendation
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
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?
The American Society for Quality ■ www.asq.org Page 2 of 4
For an overview of Six Sigma at
Cummins, see the case study “Six
Sigma Saves Nearly $1 Billion, Key
Customers, and a Company.”

3. Thus a Monte Carlo simulation was conducted with hundreds of
different interest rate scenarios to chart interest expenses on a
“y” axis and volatility on an “x” axis.
This analysis determined the optimal fixed- to floating-rate ratio
for Cummins by creating an efficient frontier curve as shown in
Figure 3. “On this curve, you minimize the average volatility and
your interest rate expense when you are roughly between a 30%
to 40% floating rate. This is how we were able to determine the
right percentage for Cummins,” explains Moore.
Of course the final step in the DMAIC process focuses on con-
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
the results of the FMEA. Cummins was extraordinarily prepared
before negotiating with banks and was quite specific about how
it wanted to complete the deal because the potential failures were
addressed in detail ahead of time.
The long-term control plan now involves a quarterly review of
the balance sheet to review the fixed- to floating-rate ratio and
ensure that Cummins’ finances remain in the target range as
determined by the analysis for this project.
The American Society for Quality ■ www.asq.org Page 3 of 4
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
11.0%
Jan-88 Oct-91 Jul-95 Apr-99 Jan-03 Oct-06 Jul-10
Historical Forward 3m London Interbank Offer Rates
3m forward curve (orange lines)
3m LIBOR spot (blue line)
Yield
The forward curve generally overpredicts where London Interbank Offer Rate (LIBOR)
actually sets interest rates.
Figure 2 Historical Floating/Forward Rate Analysis
Figure 3 Fixed/Floating Rates Achieve Risk
Diversification
The efficient frontier demonstrates that combining fixed and floating
debt can reduce interest expense volatility as well as cost.
• The fixed-floating “efficient frontier” is a graphical representation of
the tradeoff between the interest expense and volatility of a mixed
portfolio of fixed- and floating-rate debt.
• A portfolio of 100% fixed-rate debt has the highest cost, while a portfolio
of 100% floating-rate debt has the lowest cost and highest volatility.
• However, the relationship is not straight-line, as overall volatility is
reduced by combining two instruments that are not perfectly correlated.
• The tradeoff between fixed and floating is therefore one of interest
cost versus interest expense certainty.
Higher risk
Higher
cost
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
5.5%
5.7%
5.9%
6.1%
6.3%
6.5%
6.7%
6.9%
7.1%
7.3%
7.5%
4% 6% 8% 10% 12% 14% 16% 18% 20%
Average volatility
Interestexpense
100% Fixed
100% Floating
Current portfolio
Target portfolio
Minimum risk:
40% floating
Rates since 1968: U.S. 3m T-Bills vs. 10-year bonds.
Assumes 10% of portfolio is refinanced every year.
Figure 1 Cummins’ Earnings Before Interest/Interest
Rate Correlation
Observations
• Cummins’ earnings before interest (EBIT) versus interest rates:
• EBIT and average one-year London Interbank Offer Rate (LIBOR)
have shown a positive correlation over the past business cycle.
• 1992–2003: r2
= 0.84
Observations
• Cummins’ change in EBIT versus change in interest rates:
• LIBOR levels have been very low compared with the historical trends
since 1992.
• Correlation between annual percentage change in interest rates and EBIT:
• 1992–2003: r2
= 0.48
Earnings Before Interest (EBIT) Versus London Interbank Offer Rate (LIBOR)
0
500
1,000
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
0
200
400
600
LIBOR EBIT
One-yearLIBOR(bps)
EBIT(USDmm)
Financial year end
Change in EBIT Versus % Change in LIBOR
(100)%
(80)%
(60)%
(40)%
(20)%
0%
20%
40%
60%
80%
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
(150)%
(100)%
(50)%
0%
50%
100%% change in LIBOR Change in EBIT
Annualpercentagechange
inoneyearLIBOR
EBITchange
Financial year end
*based on lognormal changes

4. Rate Swap Saves Money, Reduces Risk
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.
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
Contributing to This Article
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.
The American Society for Quality ■ www.asq.org Page 4 of 4