Cummins feels effects of vertical integration

Cummins Inc. has suffered a first-quarter fall in sales which it attributes to weak industry orders and higher dealer inventories.

The company states that lower production in the North American heavy-duty truck market and weak global demand for off-highway and power generation equipment contributed to the reduction in sales.

This seems to be confirmed by statistics. Class 8 sales in first quarter (January to March) were down 7.1 per cent year-on-year, from 55,809 to 51,859 units. And down 2.9 per cent in March compared with 2015.  

Meanwhile, ACT Research Company is forecasting Class 8 truck sales in 2016 will be 18 per cent down on 2015.

However, behind the fall in sales and revenue could be a further factor to which Cummins chairman and chief executive officer, Thomas Linebarger alluded as first-quarter results were unveiled, though he failed to credit numbers to his assessment.

“Daimler has reduced the number of engines that it plans to order from Cummins while Navistar’s market share has declined,” admitted Linebarger.

Cummins latest financial figures show that sales in the first quarter fell from $4.71 billion in the same quarter last year to $4.29 billion this year.

By the same token, revenue fell from $387 million a year ago to $321million this year. External engine sales tumbled from $1.89 billion to $1.62 billion – the engine business being the largest of the Columbus, Indiana-based company’s business.

It would seem that the vertical integration place within Daimler, Paccar and Volvo is inflicting even more pain on Cummins.

Certainly, Daimler has made a long-term pledge that it would increase the numbers of in-house engines fitted to Class 8 trucks marketed by Freightliner.

This strategy could spread to Class 5 and Class 6 trucks as in November 2015 we reported: “Daimler Trucks North America is to start manufacture of its DD5 and DD8 medium duty diesel engines in Detroit, Michigan for sale in 2018. The new DD5 and DD8 engines are part of Daimler AG's strategy to develop engines in Germany for worldwide use, then adapt them for local use.”

Both DD5 and DD8 engines are from Daimler’s Medium Duty Engine Generation (MDEG), which Daimler Trucks has developed in Germany to comply with Euro VI emissions standard. The engines will be built in Daimler’s Detroit Diesel facilities.

We noted that both engines will be used in the entire product portfolio of Daimler Trucks North America. Until production can begin in Redford, Detroit in 2018, engines will be supplied from the Mercedes-Benz plant in Mannheim, Germany. And as part of the development, Daimler Trucks would invest $375 million in Detroit.

At the same time, Daimler threw a can of oil to another bonfire, by stating an intention to invest $100 million in new production facilities for the DT12 automated manual transmission (AMT) in Detroit.

In other words, another step in the direction of giving customers ‘perfectly matched drivelines’.

The North American trucking industry will be aware that the designations DD5 and DD8 represent two diesels already in production in Daimler’s Mannheim, Germany engine plant. In Europe, these engines carry Mercedes-Benz OM934 LA and OM936 LA type numbers. As such they are four- and six-cylinder mid-range engines with common bore and stroke dimensions. The swept volumes are 5.1- and 7.7-litres respectively.

Currently, Business Class Freightliners are powered by outsourced Cummins 6.7- and 8.9-litre ISB and ISL diesels. At the same time, Cummins engines are available in Class 8 Freightliner tractor units in the form of the heavy-duty 12 and 15-litre ISX units. They are offered as alternatives to the in-house DD13 and DD15 depicted by DTNA as first line fitments.

Unlike their heavier-duty stablemates, the DD5 and DD8 will initially be shipped from Germany but it is Daimler’s intention, assuming sufficient customer take-up, to establish North American assembly in 2018.

                                   The writing is on the wall

So the writing is writ large on the wall for Cummins – at least from the perspective of Daimler AG. Paccar and Volvo have similar plans to vertically integrate their diesel engine business in North America. OEM vertical integration is not some pie in the sky theory – it is happening right now and has potential to hurt Cummins.

So, how will Cummins react? This question is more difficult to answer. One possibility is that Cummins could reduce the price of its engines to its customers in the hope the three vertical integrators would pass on the benefit to their customers and not move the amount to the profit and loss account. Were they to do this Cummins’ executives could be quite cross.

Cummins has already aligned itself with Eaton Corporation in an attempt to sing from the same hymn sheet as the three vertical integration. In this way, Cummins and Eaton claim to offer a ‘perfectly-matched’ driveline and thus effectively preach the same gospel as Daimler, Paccar and Volvo.

Cummins could thus take the litany one step further and encourage Meritor to join the duo to offer truck makers a complete driveline of engine, transmission and final axle. Again, there is the prospect of some price cutting in the hope that OEMs would pass this on to the eventual customer.

But it is going to require some bold strategic moves by Cummins to head-off the on-coming storm. For example, is it conceivable that Cummins could exit the on-highway activity and concentrate wholeheartedly on the off-highway and power-generation business areas in the same way that Caterpillar of Peoria, Illinois exited on-highway? Today, Caterpillar Inc. is a vertically integrated business in the construction field.

Going forward, Linebarger sees full-year industry-production of 210,000 units, down from a previous prediction of 220,000 units. Likewise, he sees Cummins’ market share in the range 27 – 30 per cent against a previous forecast of 30 – 33 per cent. A 10 per cent drop.