(FORTUNE Magazine) – It was a foggy day in Detroit's northern suburbs, but from his office on the 15th floor of the Chrysler Group's headquarters, CEO Jim Holden could see storm clouds gathering over the auto industry. Speaking in staccato bursts, he ticked off the problems: higher interest rates, rising oil prices, overcapacity, intense pricing pressure, higher health care and labor costs, the strong dollar. "We're seeing a level of competitiveness that, frankly, we didn't predict," said Holden. "I think it's global. I've never seen financial difficulties in a runaway volume industry--and that's what we've got. It is raining on us, and it's drizzling on everybody else."

Holden, 49, was more prescient than he could have realized. In mid-November he washed out of his job after just 12 months and was replaced by a pair of executives from the German side of DaimlerChrysler. The hottest auto company of the past decade, Chrysler has become the biggest turkey of the new one. Its problems encompass everything from aging designs and untimely model changeovers to flawed marketing strategies and a huge $512 million loss in the July-September quarter. Other auto companies are struggling as well. So Holden's question is dead-on: Why are the automakers in "financial difficulty" when they're selling more cars and trucks than ever?

There are many answers. Automakers have expanded so rapidly around the world that they now have the capacity to produce 80 million vehicles annually. That's fine in a rising market, when the extra capacity enables manufacturers to sell all the cars they can. But when sales start to fall, overcapacity becomes a burden. In an effort to squeeze out every last sale to offset their costs, automakers cut prices, which distorts the market and forces other manufacturers to follow suit. Although U.S. sales of cars and light trucks are expected to reach a record 17.5 million this year, one auto executive believes they would have been two or three million units lower without the incentives.

Like companies in so many other industries, the automakers have been consolidating through alliances, minority shareholdings, stock swaps, and outright acquisitions. Left standing are six supergroups: General Motors, including Fiat, Saab, Fuji Heavy Industries, Isuzu, and Suzuki; Ford, incorporating Volvo, Jaguar, Land Rover, and Mazda; Toyota with Daihatsu; DaimlerChrysler with Mitsubishi and Hyundai; Volkswagen, which includes SEAT, Skoda, and Audi; and Renault Nissan with Samsung Motors. Each group sells cars all over the world; together they account for about two-thirds of global auto sales.

The immense scale and geographic balance of the six groups was supposed to insulate them from economic downturns and ease their transition to new products and technologies. But the road to automotive nirvana has been surprisingly rough. Although global auto sales will set a record this year, almost nobody is making record profits, and several of the groups have hit large potholes. Because of engineering misjudgments, product recalls, cross-border culture clashes, and other problems, investors have been bailing out of auto stocks like cockroaches fleeing daylight. The price/earnings ratios of GM, Ford, and DaimlerChrysler have fallen into single digits.

During the past few weeks FORTUNE asked top executives at the six supergroups to assess the industry's health. Each has his own viewpoint, but everyone agreed that pricing pressures would remain extreme. "The industry is pretty competitive and is going to stay that way," says General Motors CEO Rick Wagoner. The economic outlook around the world is not encouraging either. Wagoner and others expect a 5% decline in U.S. auto sales next year, despite high levels of incentive spending. In Europe growth has faltered, and falling legal and currency barriers between markets are putting even more pressure on pricing than in the U.S. Asian economies are rebuilding quickly from the financial collapse of several years ago, but Japan is still weak, and currency fluctuations continue to produce losses in South America.

Other shifts could be equally unsettling. Profits from the pickup trucks and sport-utility vehicles that have underpinned the U.S.'s Big Three are slipping as supply exceeds demand and Japanese automakers capture more of the business. Crossover vehicles like Chrysler's red-hot PT Cruiser--which can combine elements of a minivan, an SUV, and a passenger car--are beginning to steal sales from conventional sedans. Technology is changing rapidly and not always predictably. For example, U.S. auto companies have bet big on fuel cells to reduce emissions and increase fuel economy. But Toyota and Honda are already selling some cars with more sophisticated hybrid powertrains. Regardless of which technology ultimately triumphs, engineering a new propulsion system will require investing billions of dollars.

To some, all of the problems are just another indication that the auto industry--despite being a bulwark of national economies and a provider of transportation for hundreds of millions of people--is better suited to the 19th century than the 21st. The car business, cynics say, is dominated by production-oriented manufacturers who would rather run their factories at full capacity than find innovative ways to serve customers and reward shareholders. Squeezed between powerful labor unions at the front end of their business and independent, politically connected car dealers at the back end, they continue to do business in old-fashioned and, inevitably, wealth-destroying ways.

For proof, the critics cite the incentive war currently being waged at General Motors, Ford, and Chrysler. First the companies increased production to record levels. Then, with demand for ever more vehicles temporarily satiated, they slashed prices to move their excess inventory. Redesigned models fresh from the factory are going on sale with cheap leases and cut-rate financing; older models like the Lincoln Continental have been offered with up to $11,000 in various incentives. To stir interest in its lagging Oldsmobile line, GM decided to sell the vehicles with no money down, no monthly payments, and no interest charges for 12 months, causing a competitor to joke that Olds is the car to drive--if you have only a year to live.

The automakers are fighting a losing battle by protecting their market share. Rich incentives not only decimate profits in the short run but also hurt future financial performance; in effect, the incentives encourage customers to buy cars months before they otherwise might, thus reducing sales at some future date. The incentives also depress prices across the board, making used cars less valuable and causing automakers to write down the value of leased vehicles. Chrysler alone was forced to discount the value of its leases in the third quarter by $400 million.

Running an automaker used to be a job young boys dreamed about. What could be better than overseeing a business that made cool, sexy products everybody lusted to buy? That's not true now--and not only because the fastest road today is the information superhighway. Auto CEOs must solve the myriad problems of a complex, slow-growing industry at the same time they are under attack from environmentalists, safety advocates, plaintiffs lawyers, and government regulators. No wonder rumors constantly circulate that one or another of them is about to be fired.

During a series of interviews with FORTUNE in Detroit, New York, and Tokyo, top executives of the six largest automakers talked of the troubles ahead in what could be their most difficult period in nearly a decade.

DAIMLERCHRYSLER If an election were held today for the world's least popular auto executive, Jurgen Schrempp would win in a landslide. Investors are angry at him because DaimlerChrysler's shares are trading 46% below their yearly high. Chrysler's 131,241 employees are none too happy, either, to have Mercedes executives installed as their CEO and COO. In effect, their worst fears have been realized: The Germans have taken over. Schrempp, 56, now says that was always his intention. All that talk about a "merger of equals" between Daimler and Chrysler was just a convenience to get the deal done. "It was in spirit a merger of equals," Schrempp says. "However, we are living in a changing world."

For sure. Chrysler standbys like the Jeep Grand Cherokee and Dodge Ram pickup are aging quickly, and the newly launched 2001 minivans failed to leapfrog the competition the way previous generations did. Pickups, vans, and sport utilities have been Chrysler's profit engine, but now the company is ladling out incentives to sell them, even as it has been absorbing increases in health care and labor costs. "This has been an unpleasant surprise," acknowledges Schrempp. Even before he fired Holden, Schrempp conceded that the atmosphere at Chrysler "is not cozy." But he continues to argue that the merger will pay off, brandishing charts that show big savings from joint projects like sharing powertrains across Mercedes and Chrysler vehicles. Though some management board members are reportedly discussing selling off part of Chrysler, Schrempp has adamantly rejected the idea in the past. "It would be the nth degree of stupidity," he says. "Why should I give up on a fantastic strategy because I have a problem?"

Schrempp has another problem at Mitsubishi Motors. Daimler bought 34% of the Japanese company earlier this year; since then Mitsubishi has reported the largest first-half net loss in its history, doubled its projected loss for the full year, and admitted to hiding records of vehicle defects stretching back 20 years. Schrempp doesn't seem overly concerned. "[I] always make a distinction between a temporary operational challenge in a company and a good strategy," he says. "I tell my people that when there is a problem, a bad manager runs away and a good manager solves it."

By Schrempp's reckoning, 2000 has been a good year for operations and strategy. Mercedes is breaking sales records, and its Smart micro-car is gathering market momentum. DC increased its presence in Asia when it bought 10% of Korea's Hyundai, consolidated its position in heavy trucks with two major acquisitions, and took steps to sell off its aerospace business. Schrempp says that the strategic part of his work is complete and that now he's ready to roll up his sleeves and make it work. "I have so much fun and so much excitement, and there are so many things to do," he said in a recent interview in New York City. Expect him to spend considerably more time in the U.S. next year, talking with analysts and investors to get the stock price up and masterminding Chrysler's recovery.

FORD MOTOR Even before Ford's problems with Firestone tires became public, Jac Nasser had become one of the U.S.'s highest-profile CEOs, with confidants ranging from Jack Welch to fellow Australian Rupert Murdoch. He had been pushing relentlessly to move Ford beyond the low-margin volume car business by making investments in luxury vehicles like Land Rovers and in less capital-intensive service businesses like Hertz rental cars. So he hardly needed the exposure--much less the notoriety--that came with his leading role in the Explorer controversy. Still Nasser, 53, took center stage, testifying before Congress, managing the recall of 6.5 million tires, and starring in television commercials to rebuild consumer confidence.

Though the Screen Actors Guild won't be offering Nasser membership anytime soon, he got generally good reviews. Far more controversial has been his decision to exonerate the Explorer and pin responsibility for the rollover accidents entirely on Firestone. Quietly but firmly, Nasser made the point again during an interview one recent Friday evening: "We've got probably the strongest sport-utility vehicle," he said. "Firestone manufactured hundreds of millions of tires, and unfortunately a very small percentage in total were defective." The fallout from the incident is continuing, with endless litigation, talk of federal safety legislation, and marketplace turmoil. Sales of the current-model Explorer fell 16% in October, and Ford faces a delicate challenge in trying to attract new customers without losing its old ones when it introduces a redesigned version early next year (see box).

Having made $7.2 billion in 1999, Ford is the world's most profitable auto company. But it will have to work hard to maintain that ranking. Sales of its high-margin F-150 pickup truck have begun to slow because of the weaker economy and strong products from GM and Toyota. "Competition is tough," concedes Nasser, "but that's good because it sorts out the quick from the slow." It will make up some of the lost profits with its new Escape crossover vehicle, but Ford's European business, like GM's, is losing money--and for many of the same reasons. Mazda, its Asian affiliate, runs in the red too, and Ford has been losing some $1,300 per car in South America despite higher sales.

Nasser has a history of rising to a challenge, but the one he faces now seems particularly tough: He must strengthen Ford's performance in every part of the world. If he can put the Explorer problem behind him, he'll have a good chance of maintaining Ford's momentum during the coming downturn.

GENERAL MOTORS With his promotion to CEO last June at age 47, Rick Wagoner became the youngest person ever to run the world's largest automaker, beating the legendary Alfred P. Sloan Jr. by eight months. Sloan was an outsider who worked for a bearings company that was acquired by GM. Wagoner is a GM lifer, with tours of duty in Brazil, Switzerland, and Canada, plus New York City and Detroit. Having worked closely with Chairman and former CEO Jack Smith on GM's turnaround in the early 1990s, Wagoner aims to keep fine-tuning the engine rather than do a major overhaul.

But despite his relaxed jock persona (he played college basketball), Wagoner is sending signals within the company that good enough is no longer good enough. He has set aggressive stretch targets for global market share, and he is discarding old-line executives he doesn't think can meet the targets. Wagoner is demanding that GMers finally put aside the internal competition installed by Sloan 75 years ago and focus instead on what's going on outside the company. "That's the way we'll move the needle," he said in an early November interview.

Although GM has the broadest lineup in the industry (seven divisions, with 49 models in the U.S. alone), it lacks the resources to keep them all fresh. With its domestic market share under pressure, the company has been forced to focus on high-profit segments (midsized cars, medium- and full-sized sport utilities, pickup trucks) until it can rebuild higher-volume categories like small cars. Wagoner believes that GM can support all its divisions--including struggling Oldsmobile--by eliminating product overlaps and giving dealers more than one brand to sell.

In Europe the company has been losing money because of tough price competition and more cross-border shopping, not to mention its aging product lineup. Wagoner insists that he can steer GM to breakeven next year, and says that eventually the alliance with Fiat should help reduce the costs of new products and technology. GM has chosen to buy small stakes in companies rather than acquire them whole, which looks like a smart strategy, given Daimler's problems with Chrysler. "I think we've avoided some of the issues that come up when somebody becomes a 100% owner," says Wagoner.

In Japan, GM and its affiliated companies--Fuji Heavy Industries (maker of Subaru), Suzuki, and Isuzu--sell more cars than anyone but Toyota. To further strengthen its presence in Asia, GM is negotiating with Korea's bankrupt Daewoo, though Wagoner says the outlines of a deal aren't yet clear.

Unlike some recent GM bosses, Wagoner not only wants better results but wants them fast. "[You] don't sit here with a ten-year plan and say things are going to be great in years nine and ten," he says. "If you don't get years one through three right, you won't have a chance to execute those." Despite his youth, Wagoner is unlikely to break Sloan's record of 23 years as CEO. But if he can rebuild GM into a global force commensurate with its global size, he will have made a name for himself all on his own.

TOYOTA While the rest of the auto industry zigs, Toyota zags. Global consolidation? Toyota is sticking with its traditional partners. Sell parts-making operations to boost returns? Toyota is strengthening ties, not dissolving them. Hot new models? Toyota would rather focus on new factories.

When it does follow conventional wisdom, Toyota tends to do so with uncommon thoroughness. Earlier this fall, on the 16th floor of Toyota's black-granite office building in an out-of-the-way Tokyo neighborhood, Chairman Hiroshi Okuda, 67, presided over a lunch in an austerely decorated conference room. The entree: three-decker egg-salad sandwiches on white bread. Unusually impassive, Okuda seemed disengaged from the conversation, which was conducted through an interpreter, until the subject turned to Toyota's "boring cars." "We have many criticisms that our cars are not cool," said Okuda, warming to his topic. "Therefore we decided to send our designers and chief engineers outside Japan for business trips, and such efforts are now finally bearing fruit. We are still viewed as a very conservative company, and that's something we need to change."

Are Toyota's cars cool yet? Funky may be a better word for new small cars like the Echo. But customers don't seem to mind. Toyota has been winning market share for several years in the U.S., where its insignia now decorates the hood of almost as many vehicles as Dodge's. Toyota has a keen market sense and responds more quickly to changing trends than almost anyone. Its new full-sized pickup truck is stealing sales from Detroit; a full-sized sport-utility vehicle, coming later this fall, will likely also be successful. Toyota has been a leader in pioneering new concepts with crossover vehicles, like the popular Lexus RX300, and has two more under way: an SUV/van blend called the Highlander and a redesigned RAV4, an SUV/car mix.

In Japan, Toyota is having its most successful run ever, capturing more than 43% of passenger-car sales with offbeat new models called Vitz and FunCargo. Europe, with its nationalistic loyalties and entrenched local dealers, has been a graveyard of Toyota's ambitions for years, but that seems to be changing. The company is building a new assembly plant in France, of all places, that should enable it to boost its sales in Europe to 800,000 by 2005, raising its market share from 3.5% to 5%.

Toyota has also developed a low-emission hybrid engine that uses two motors, one electric and one gasoline. The company has installed it in the Prius, which is on sale in the U.S. and Japan and gets 48 miles per gallon. President Fujio Cho says that eventually 35% to 50% of Toyota's cars could be hybrid powered--far more than any of its competitors are contemplating. (Fuel cells have dominated the discussion about environmentally sensitive powertrains. But none of the auto companies will have commercially feasible fuel cells until later in the decade, if then.)

Toyota's profit margins--2.5% for the six months ended Sept. 30--are about half as high as they should be, and it sits on a pile of cash that in the U.S. would make it a prime takeover target. Still, investors love it: Toyota commands a price/earnings ratio of more than 40, giving it a market capitalization greater than those of GM, Ford, and DaimlerChrysler combined. "We are a growth company," says Okuda. "There is still room for us to increase volume."

Perhaps the world's other automakers should start zagging too. RENAULT NISSAN It was 6 P.M. on a warm October evening in Tokyo, but Carlos Ghosn, 46, was as fresh as a Japanese cherry blossom--and bubbling with energy. "We're not smarter than other people," he said. "We are just doing the basics of this industry, but we're doing it intensely and we're doing it fast." Modest but no-nonsense, the Brazilian-born Ghosn (his name is pronounced with a hard "g" and rhymes with "cone") is producing breathtaking results at once dysfunctional Nissan. By setting firm numerical targets for cost cutting and productivity, and motivating employees to meet them, Ghosn is in the early stages of resurrecting a company many people thought was beyond saving. Moreover, he is doing it in a country with impenetrable business practices that stubbornly resists change and doesn't like outsiders.

Despite weak sales in Japan and unfavorable exchange rates, Ghosn is leading Nissan back into the black after years of losses. For the fiscal year that ends March 31, 2001, Nissan expects to report a $2.04 billion operating profit, vs. $778.9 million a year ago. Ghosn has reduced overhead, cut purchasing costs 10%, and slashed global marketing expenses by more than $280 million. "We're going to start a virtuous circle," Ghosn says. "Motivation leads to performance, and performance increases motivation, which then feeds the performance. It is easy to explain, difficult to achieve." Jurgen Schrempp has begun referring to Ghosn as his "icebreaker," because, says Schrempp, "he has been doing a lot of things at Nissan that are now so much easier for us to do at Mitsubishi."

Ghosn was all but unknown in 1996 when Renault Chairman Louis Schweitzer plucked him from tiremaker Michelin and installed him as Renault's executive vice president. Ghosn helped turn the French automaker around, and after Renault bought 36.8% of Nissan in March 1999, Schweitzer dispatched him to Nissan. Ghosn took 16 other Renault executives with him and devised a wide-ranging "Nissan revival plan" that included drastic measures formerly unthinkable in Japan: closing plants, reducing employment, and terminating longtime supplier relationships. By convincing everyone, including the Japanese government, that Nissan was in critical condition, Ghosn managed to win broad public support for his plan.

Cost cutting represents the low-hanging fruit of any turnaround, so Ghosn is now trying to put some pizzazz back into Nissan's products. Dominated by engineers, Nissan used to launch cars with little sense of their marketability--and even less of their profitability. Ghosn has insisted that potential customers for each car be identified before it is designed, and that the cost structure be made consistent with the customer base. In other words, Nissan will no longer project unrealistic profits for small cars like the Sentra that simply don't make as much money as luxurious models like the Maxima.

Ghosn says it will take time to revive the Nissan name--an especially critical job in Japan, where the company's market share has shrunk to 17% from twice that a quarter century ago. "It's too easy to talk about brand," says Ghosn. "We'll be unveiling our new brand identity and our brand promise step by step, at the same time we show concrete examples. Give us a little time. You don't renew the product line in three months. By 2002 we should be coming back."

Nissan is reviving faster in the U.S. Sales are up 13.3% this year, led by the popular Xterra sport utility, which was designed for the extreme-sports crowd. The company is boosting production at its Tennessee assembly plant and intends to build a second plant in Mississippi that would assemble a new pickup, a sport-utility vehicle, and a minivan for 2003. If Ghosn can maintain the momentum he will become the hottest executive in the industry.

VOLKSWAGEN Another player absent from the 1990s race toward global consolidation was Volkswagen. But that's only because it had already crossed the finish line. Audi, Spain's SEAT, and Czechoslovakia's Skoda all had become part of VW by early in the decade. VW also got a big lead in the critical job of sharing parts among car lines, so today there is considerable commonality among Audis, VW cars, and Skodas of the same size. Customers don't seem to mind the similarity, and the savings are paying off; the company expects to report record profits this year. Soon VW will add another dimension to parts sharing by using some of the same components--starters, water pumps, suspension pieces--in cars of different sizes.

VW has strong operations on four continents. It outsells all of its competitors in Europe, although it too is coping with slumping sales in Germany. In the U.S., Americans are buying more VWs than at any time since their love affair with the Beetle ended in the 1970s. Sales have been growing in double digits since 1993 and are expected to reach 350,000 this year--putting VW well ahead of Oldsmobile and closing in on Mercury. And VW will soon offer a sport utility that it's developing in cooperation with Porsche. VW is a market leader in Brazil, where it expects its financial performance to improve along with the economy next year, and it controls more than 50% of sales in fast-growing China.

But Chairman Ferdinand Piech, 63, has plenty more to do before he retires at the end of 2002. Because Mercedes and BMW have increased the number of models they sell at the low end of market--where VW is king--Piech is moving the company upscale. Next year VW will start installing larger eight-cylinder engines in its popular midsized car, the Passat, in a bid to steal sales from its luxury German rivals. And now that it has the rights to Great Britain's hallowed Bentley brand,VW is preparing to introduce a less expensive version in two years. "We have been constantly improving our profit base," says Jens Neumann, a member of the VW management board. "Our competitive principle is, 'The best shall win.'"

Managing cross-border alliances is a skill that will be essential for executives of the auto supergroups. Says Nissan's Ghosn: "This crossing of cultures, of companies, and of functions is at the heart of success. The company that is able to do this in the most effective way, in my opinion, will be the winner." That the French so far have had better results working with the Japanese than the Germans have had with the Americans is a totally unexpected turn of events.

Whether it is the success of a Ghosn, the emergence of hybrid-powered cars, or the appeal of an original new product like the PT Cruiser, the auto industry--despite its size and inertia--still has the ability to shock and surprise. So the disruptions that will inevitably be caused by shifts in customer preferences, improvements in technology, and the vicissitudes of national economies will almost certainly be accompanied by unexpected developments that could move the industry off in another direction entirely. Which makes it even more essential that the leaders of the industry's six largest groups remain focused, flexible--and prepared for the curves ahead.

REPORTER ASSOCIATE Feliciano Garcia

FEEDBACK: ataylor@fortunemail.com