Water Heaters - tankless gas temp fluctuations

We installed a tankless gas water heater and are very unhappy with it. I knew that we'd get a blast of cold when we first turned on the hot but it is difficult to regulate the temp because it turns itself on and off. The pressure decreases remarkably from the time we turn it on (it's cold) to when it is hot. When we turn on a second "hot" we have to adjust the first all over again. We purchased a larger than necessary unit so we'd be able to run 2 hot faucets at a time. We understand how the thing is supposed to work (full cold until the water flowing through the heat exchanger has had a change to warm up and colder water in will result in less volume out at the same temp) but I can't believe that this is the way things are supposed to run. We have a short run (maybe 12' total) from water heater to kitchen sink and I still get a blast of cold each time I try to rinse a dish. Any suggestions? How about an auxilairy storage tank (electrically heated) before or after the "on demand"? This would seem to negate the energy savings we were striving for but what we have now is not satisfactory.

Something is not right. If you are saying that you turn on the faucet and run hot water, but the heater turns off and on, then you do not have enough flow through the heater. You have a restriction somewhere. There might be a clogged screen on the cold water into the heater, or maybe the aerator screen at the faucet.
If the heater works properly, it turns on (or "lights") as soon as it senses adequate water flow (usually aroung 3/4 gpm) and stays lit as long as there is a minimum water flow. If you turn off the water, the flames go off. The water in the pipe should still stay hot for awhile (consider wrapping with foam pipe insulation).