(FORTUNE Magazine) – All history, it has been said, can be condensed to two words: "challenge" and "response." They determine the fate of mighty empires. They even apply to the everyday problem of air pollution from small, handheld power equipment such as trimmers, edgers, leaf blowers, and chainsaws. The challenge? Federal and state emission-reduction standards imposed on a previously unregulated $1.5-billion-a-year industry, forcing manufacturers to change the way they make two-stroke engines, the pint-sized predominant power source for the tools.

The response? Intense engineering and marketing that have burned through tens of millions of dollars, as well as lobbying that has pitted regulators against most of the industry, and engine makers against one another. Some of the manufacturers said that the standards couldn't be met without sacrificing quality and raising costs excessively. Others, delighting in proving their rivals wrong, have aggressively supported the tough rules. The challenge has also contributed to the demise of the industry's trade association and forced engine makers to produce separate models for enviro-conscious California. And it has opened a marketing opportunity for four-stroke engines, which cost more but run cleaner.

The whine of a two-stroke engine is as much a part of the American landscape as baseball and homecoming parades. From California farms to leafy Connecticut suburbs, they're ubiquitous. Along with the noise--who hasn't been roused from a weekend slumber by a leaf blower?--it's the puff of blue smoke and the pungent smell of the gas-oil mix that distinguish the small, peppy two-strokes from their larger cousins.

At least 30 million handheld products are in use in the U.S., where about 1.5 million blowers, two million chainsaws, and five million trimmer-brush cutters are sold each year. Roughly two-thirds of the market is consumer grade, and the rest is heavy-duty equipment for commercial users. The handheld industry arose in the post-World War II era, when U.S. companies like McCulloch, Homelite, and Poulan owned the market. In the 1970s imports from Japan and Germany began to pour in, and now the business is dominated by foreign-owned companies like Germany's Andreas Stihl, Japan's Kioritz, and Electrolux, the Swedish giant that owns Husqvarna and Poulan.

Most U.S. handheld companies today are distribution arms of corporations based abroad, where the majority of products are manufactured. Domestic manufacturers include industry leaders like Echo and Stihl. Echo of Lake Zurich, Ill., imports short blocks--the bare bones of an engine--from Kioritz, its Japanese parent company, and does final assembly. Stihl's U.S. operation, based in Virginia Beach, Va., will make nearly two million handheld products in the U.S. this year, more than at any other Stihl location. While most engine companies make and test their products abroad, Echo and Stihl USA have constructed state-of-the-art testing centers onsite to ensure compliance.

Compared with the auto industry's massive efforts to clean up car emissions in the 1970s, the handheld industry's struggle is Lilliputian. But it's a current struggle, with stringent federal emission standards starting to phase in this year, and it's no small matter to the companies affected. "Is this the greatest challenge ever faced by handheld engine manufacturers? No question," says Fred Whyte, president of Stihl's U.S. operation. "Meeting the regulations was one thing," adds Larry Will, vice president of engineering at Echo, which often plays Ford to Stihl's GM. "Meeting the regulations and surviving was another."

But amid the carnage are some inspired bursts of genius, including many design innovations that have met the emission standards with little or no loss of performance. The new engines--some are several years old and others are being released this year--cost about 10% to 15% more on average. But they are quieter and cut fuel consumption as much as 30%, and some heavy-use models can pay for themselves in a year or two. That's quite a selling point in this price-sensitive industry, where margins are slim, since upwards of 70% of sales take place at big-box retailers like Home Depot, Wal-Mart, and Lowe's, which maintain a vise grip on prices.

Long the workhorses of the handheld-equipment industry, two-stroke engines are extremely reliable, maneuverable, lightweight yet powerful, and inexpensive--but inherently dirty. First, the basics: In internal combustion engines, fuel is ignited in a cylindrical chamber. The explosion pushes down a piston, which turns a shaft, and that rotation drives the machine. The two-stroke is so named because each explosion creates a downstroke of the piston (or power stroke), then a rebounding upstroke. Intake and exhaust valves are not necessary, since the motion of the piston covers and uncovers ports in the cylinder. Unlike the more complex four-stroke engines, which have a separate oil reservoir, two-strokes ensure lubrication of all moving parts by burning a mixture of fuel and oil in the same combustion chamber.

Sounds like a great little engine that could, but here's the rub: Since the two-stroke uses the incoming fuel charge to expel (or "scavenge") exhaust gases from the previous combustion, about 30% of that fresh fuel mix escapes unburned, releasing hydrocarbons as well as oxides of nitrogen (NOx), two primary precursors of ozone. "Two-strokes are among the dirtiest engines on the face of the earth," says Richard Varenchik of the California Air Resources Board (CARB), which sets emission standards for that state. According to the federal EPA, small handheld engines in trimmers and blowers contribute 5% of the total U.S. mobile-source (i.e., nonfactory) hydrocarbon and NOx emissions. Engine makers have disputed that figure, arguing that it's really less than 1%.

The origins of this campaign go all the way back to the last time a Bush occupied the White House. In December 1990, CARB ordered a 30% reduction in handheld engine emissions, to take effect in 1995 and to be followed by a second cutback later. The first tier of California regulations did not rock the industry. The two-stroke manufacturers were able to meet the new standards by simply ensuring that their engines ran leaner--that is, with a lower proportion of fuel in the fuel-air mix.

"We were able to tinker with the existing product lines with minor changes," says Jay Larsen, product marketing and communications manager at Shindaiwa, the American subsidiary of Shin-Daiwa Kogyo of Japan. But the second tier of California regulations that loomed for 1999, bringing the total clampdown on emissions to 80%, was a different matter. The industry players were faced with a choice: litigate or innovate. Meanwhile, controversy was brewing in Washington, D.C.

In emissions regulation it's old hat that "as California goes, so goes the nation." In 1990 the EPA got the authority to enforce what it calls "nonroad" emission standards through an amendment to the federal Clean Air Act. After California established its two-tiered framework, the EPA promulgated its own Phase I, which roughly followed the CARB regulations and called for a 32% reduction in emissions by 1997 for most models. Before that, the EPA spent three years discussing its more stringent and controversial Phase II framework with the industry, state air-quality-control agencies, and environmental groups. The contentious talks ended without a consensus. But by 1998 the agency was so impressed by some companies' improvements that it laid down standards as tough as California's while allowing more time--until 2005--for them to take full effect.

The earliest engines to measure up were four-stroke models. They have drawbacks, notably more parts, which makes them much heavier. A couple of extra pounds means a lot to a landscaper who has to lug around a blower in the hot sun. Moreover, since only every fourth stroke is a power stroke, instead of every other stroke, the engine's power-to-weight ratio is lower. Some companies found the four-stroke path fraught with problems, but not Ryobi Outdoor Power Products, a formerly Japanese-owned manufacturer now owned by MTD Products in Cleveland. Ryobi was the first to meet the more stringent rules with a four-stroke trimmer, which it introduced in 1994. The engine took three years and cost more than $10 million to develop. Ryobi's current four-stroke handhelds are each, on average, some $30 pricier than its comparable two-strokes, which were not compliant with CARB regulations until this year. Another company that took the four-stroke path was Honda Power Equipment, which, incidentally, sells engines to MTD and others.

Meeting the standards with two-strokes was on the face of it much more difficult. PPEMA, the handheld industry's trade group (Portable Power Equipment Manufacturers Association), argued that the second tier of California regulations would "virtually eliminate" all two-stroke gasoline engine products in the state. Yet much to the chagrin of PPEMA and most of its members, two companies were able to meet the advanced standards well before the deadline.

One was RedMax-Komatsu Zenoah America, a Norcross, Ga., subsidiary of Japan's Komatsu. RedMax spent $1.5 million on a "stratified charge" design, which injects a shot of pure air between the exhaust gases and the fresh charge of fuel coming in. Instead of losing a third of the fuel to the exhaust, the engine emits air. To accomplish that, RedMax worked with its carburetor supplier, Walbro, to build a new two-barrel carburetor. Japanese engineers originally dubbed the engine Air Head but quickly scrapped that name when the Americans explained what the expression means in their country.

RedMax's Strato-charge engine received mixed reviews at first, mainly because it ran quieter, and users equate noise with power. But customers warmed to it when they found it cut fuel consumption by 34%. The engine received a ringing endorsement in 1999 when Stihl bought 60,000 of them to help make its products compliant in California.

Japanese-owned Tanaka also met the regulations, but in a different way. First, it worked alongside rather than against CARB, receiving funding from the state for a joint fuel-injection research project that has not yet yielded a consumer-ready product but signaled Tanaka's realization that fighting the regulatory tide was pointless. "We recognized [the agency's] conviction," says vice president Randy Haslam. "There was no way they were going to back off the rule."

On its own Tanaka came up with a design, dubbed PureFire, that involves a stratified charge plus a catalytic converter in the muffler to clean the exhaust gases. The use of converters is hotly debated in handheld circles. They convert emissions to water and carbon dioxide, but they are expensive, add weight to the product, and produce high-temperature exhaust exceeding 1,000 degrees Fahrenheit. Since the converter can't do the cleaning job alone, the PureFire also slashed emissions by changing and better controlling the air-fuel transfer from the crankcase to the combustion chamber, reducing the loss of unburned fuel.

RedMax and Tanaka are smaller players in the handheld market, but the introduction of their two-strokes in 1998 came at a critical juncture. California was mulling a one-year delay in the implementation of its Tier II regulations, from 1999 to 2000, and the EPA had just published its proposed Phase II standards. At an exhaustive, ten-hour CARB board meeting in Sacramento in March 1998, the companies that had met the deadline (Tanaka, RedMax, and Ryobi) pleaded with CARB not to delay implementation. PPEMA, the trade association, proposed a less stringent emission standard that called for about a 50% reduction from Tier I levels.

At the meeting, most PPEMA members complained once again that the standards were too onerous and not technologically feasible, especially for cost-sensitive consumer products. "I wouldn't call it a ban [on two-stroke engines], but it's making it necessary for us to go to some technologies that we feel we can't afford to put on these units," argued Echo's Larry Will. A catalytic converter won't work on an 80cc chainsaw, Stihl's Fred Whyte maintains to this day. "We'd set fire to forests." Jim White from McCulloch, the chainsaw maker that dominated the industry in the 1950s, told CARB that its proposed regulations would "take us out of the market." McCulloch in fact filed for bankruptcy in 1999 and was bought by a Taiwanese company.

Their arguments, and those of almost a dozen other engine and landscaping industry reps, fell on deaf ears. The CARB members had seen some compliant machines in action outside the hearing room before the meeting. "Industry, while always complaining about regulations, without exception finds the wherewithal to meet the standards," says Bill Becker, executive director of the State and Territorial Air Pollution Program Administrators.

The meeting ended with CARB sticking to the proposed new standard for Tier II but allowing a one-year delay. The new rules also require extensive testing, in which the engine makers have made significant investments. "The industry underestimated how problematic compliance was going to be," says Don Purcell, former president of PPEMA, which disbanded late last year amid disagreement on what stance to take with regulators. Most of its members joined the Outdoor Power Equipment Institute, an organization whose members include lawn-mower makers.

The engineering advances introduced by RedMax, Tanaka, and others helped persuade the feds to raise the ante quite a bit on their own proposed Phase II regulations. Originally the EPA sought a further 30% cut in the emission level remaining after Phase I's 32% reduction. Now it ordered a further cutback of 70%, to be phased in from 2002 to 2005, which will leave engines running 80% cleaner than before Phase I. It's rare for the EPA to be as tough on emissions as California. No company had more to do with its decision than Deere & Co., which had previously opposed the California standards.

The $13-billion-a-year farm machinery giant had come up with a low-emission technology for its Homelite line of two-stroke consumer handheld products, which it had purchased only a few years before. The design, called compression wave, is similar to RedMax's stratified design. What was not similar was the full-court press that Deere's lobbyists put on the EPA to persuade the agency to stick with the more stringent Phase II standards, despite the howling protests of PPEMA. Deere's efforts paid off, as the EPA adopted the tougher standards in July 1999.

But what happened next was bizarre. Although Deere licensed the technology to Stihl, not a single product embodying it has ever reached the market. Last November, moreover, Deere sold the Homelite division to TechTronics Industries (TTI) of Hong Kong. Under a squeeze from big-box retailers, Homelite had lost $100 million in 21 months. Deere has few friends in the handheld industry today. "What's fascinating is that Deere persuaded the EPA, and then the industry gets screwed," says an industry source closely involved with the EPA. Deere won't comment, but in fairness it must be said that its intense lobbying efforts may have incited fresh waves of innovation among the handheld manufacturers.

Those waves are starting to crash ashore on the market. Stihl, Shindaiwa, Echo, and others have new designs slated for release this year that meet not only current emission standards but also the EPA's 2005 mandate. The models are clever hybrids that meld the advantages of two-stroke and four-stroke designs. Shindaiwa, for example, spent upwards of $10 million developing its T2500 trimmer, which it has just begun shipping to distributors. It features Shindaiwa's new C4 technology (compression-charged clean combustion), which eliminates the need for an oil reservoir or a catalytic converter, runs on the same fuel-oil mix as a two-stroke but has four-stroke components such as overhead valves.

Stihl's 4-MIX, developed at a cost of $12 million, is another hybrid that acts like a four-stroke but is lubricated like a two-stroke, and it has only three ounces of additional parts. The company plans to ship 4-MIX trimmers to California this summer, with a national rollout slated for later this year. Echo is more coy about its plans but says it will have a product out this summer that improves fuel delivery and combustion within a two-cycle framework. Echo does admit that because of the regulations, 84% of the nearly 200 products it sells this year will have new engines. "I'm losing my hair, and I've gained 35 pounds in the past five years," says Steve Bly, Echo's vice president of manufacturing.

Other engine makers, like Briggs & Stratton, know a market opportunity when they see it. The company has developed its first four-stroke engine suitable for handhelds, which it is already selling to Electrolux. And RedMax is hard at work on its second-generation stratified design, slated for introduction this fall. The engineers had better stay busy, because next on the EPA's regulatory agenda is permeation, or emission of vapors from the fuel tanks of handhelds. Challenge, response: History never ends.

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