The New Detroit May 27, 2009, 5:00PM EST

The Tough Road Ahead for GM and Chrysler

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Chrysler's challenge is starker still. The Jeep brand remains strong but has undermined its rugged image by selling vehicles designed for suburban commuters. Dodge buyers tend to have lower incomes and credit scores, a dicey niche in these parlous times. And Chrysler's future partner, Italy's Fiat (FIA.MI), is wondering if the Chrysler brand should be preserved. Even more debilitating, Chrysler is dogged by subprime-quality rankings from Consumer Reports and J.D. Power. "That's tough because you are always marketing into a headwind of facts on the Internet that contradict your ad messages," says Gary Dilts, president of J.D. Power's auto industry group.

Marketing means little, of course, unless you have the right mix of products. With lower costs, GM theoretically will have more money to spend on Buick and GMC, which were both long starved of new vehicles. For the first time, Buick will get a nearly full line of models, says Thomas G. Stephens, GM's new product boss. Buick and GMC will be more upscale than Chevy, the hope being that they will attract a more well-heeled customer and help GM retain market share. That's important because to survive, the company will need to sell enough cars to both pay down debt, which could still be $10 billion to $20 billion, and fund new vehicle development.

Chrysler, meanwhile, is pinning many of its hopes on an alliance with Fiat, whose CEO, Sergio Marchionne, has promised to supply much-needed small cars for the U.S. Thing is, Fiat left the American market a quarter-century ago because it couldn't get traction with its vehicles. Chrysler, by the way, will emerge from bankruptcy owing some $21 billion. Unless the government wipes some of it away by taking a bigger stake, that will be a serious burden.

A Pivotal Moment

Both GM and Chrysler say they can hang on to their market share in the U.S. "Our objective is not to be easy pickings," says Henderson. But given the savaging their brands have taken vs. the relative strength of their competitors, GM and Chrysler almost certainly will lose ground. Five years hence the U.S. auto market could look much like Europe now, with two tiers: several midsize companies on top and a bunch of minnows fighting it out below. GM could have anywhere from 14% to 17% of the market, down from 19.1% now, putting it in the middle of the pack with Ford and Honda, while Toyota ends up with nearly a fifth of the market. Worst-case, Chrysler's share could erode to 6%, smaller than Nissan Motor (NSANY).

As GM and Chrysler labor to remake themselves, it's important to remember that the Obama Administration has its own agenda, and it doesn't always jibe with business imperatives. Treasury has laid out a clear path for GM and Chrysler to become viable enterprises, but new regulations that boost fuel economy threaten to make cars more expensive with no guarantee that consumers will pay for the new gasoline-sipping vehicles. So while the government's policy is to preserve Detroit, its rules make it harder for carmakers, especially weak ones, to make a buck. Much depends on what happens to gasoline prices over the next few years. Henderson says they will rise, prompting consumers to pay more for efficient cars.

The stakes for this risky experiment in industrial policy are high. Failure would be not just a political and economic catastrophe for the Obama-ites, it also could hurt America's long-term prospects and erase a swath of the nation's industrial capability. We are at one of those pivotal moments in history when one technology (the internal combustion engine, in this case) is poised to give way to another (electric motors or even more exotic alternatives). Team Obama clearly thinks the risk is worth taking because an America without its own 21st century auto industry would be a diminished America. The government has given GM and Chrysler a fighting chance. The question is whether they can win over car buyers and get through the next few years of hardship without failing and being carved up or displaced by foreign-owned powers.

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Welch is BusinessWeek's Detroit bureau chief. Kiley is a senior correspondent in BusinessWeek's Detroit bureau.