(FORTUNE Magazine) – GM'S FIRST QUARTER WAS A SLOW-MOTION car wreck. Buyers stopped responding even as the company's sales incentives neared the $4,000 barrier. Sales of high-profit SUVs like the Chevrolet Suburban tumbled in the face of $55-per-barrel oil and more modern vehicles from rivals. And GM's lovingly nurtured and heavily marketed new models--the Pontiac G6, Buick LaCrosse, and Chevy Cobalt--turned out to be simply too timid to excite consumers.

For several weeks in early 2005, GM executives tried to put the best gloss on events, grabbing at bits of encouraging news when sales showed glimmers of improvement. But when results were tallied in early March it was clear that the company's North American operations, which provide nearly two-thirds of its automotive revenue, were hitting a wall. Unsold cars had piled up on dealers' lots and market share had shrunk to 24.4%, down three full points from a year earlier. GM tried to pull out of the skid by slashing prices on some midsized SUVs and reassigning a top executive to revamp its sales strategy. It wasn't enough. THE NEW CARS AREN'T HITS blared a page-one headline in Automotive News, a trade weekly, in early March.

Yet even savvy GM watchers were surprised by chairman and CEO Rick Wagoner's early-morning conference call with investors and journalists on March 16. Sounding chagrined yet resolute, he announced that sales in 2005 are running far below what GM had forecast, and that it won't be able to achieve the earnings targets it had provided Wall Street only two months earlier. Instead of breaking even for the first quarter, GM now expects to lose $850 million. For the full year, it forecasts that earnings will be as much as 80% lower than previously indicated. Cash flow, a closely watched measure at a capital-intensive company like GM, is hurting too. It will swing from $2 billion positive to $2 billion negative.

The scary news crushed GM's stock, which lost $4.71 a share that day, falling to $29.01. In the past ten months GM has lost fully 40% of its market capitalization--Harley-Davidson's is now higher. Analysts pulled out old stock charts to discover that GM shares are selling for $20 less on a split-adjusted basis than they were in 1965. Credit agencies immediately reviewed GM's bond rating. Another downgrade by Standard & Poor's would push GM below investment grade, sharply raising its borrowing costs and making its auto loans more expensive than competitors'.

No bankruptcy looms; GM had $23 billion in cash at the end of 2004, and management and the board simply aren't thinking in those terms. Yet there are no silver linings to be found in any of the clouds. Wagoner's announcement reinforced the impression that GM's 40-year slide in North America is not just continuing but accelerating. It created a picture of a hapless giant that doesn't know its business well enough to forecast results with any accuracy. And in this era of shaky CEO tenure, it also raised questions about the longevity of Wagoner and his team.

Since its last financial crisis in the early 1990s, GM has taken big strides to reduce costs, improve quality and productivity, and make its cars more relevant to consumers. It remains the dominant force in big, lucrative SUVs. Its finance arm, GMAC, is a money machine. It has become the No. 2 Western vehicle maker in China, where its market share is growing rapidly. Its turnaround in Europe is succeeding even faster than planned.

But rivals like Toyota and Hyundai are moving as fast or faster, and past mistakes and customer dissatisfaction have left deep scratches on GM's brands. The dream team Wagoner assembled by hiring retired Ford executive John Devine and former Chrysler executive Bob Lutz has failed to produce the expected product revival. Cadillac's notable success has been overshadowed by big declines in GM's other brands. (How long has it been since a neighborhood teenager aspired to own a pavement-ripping Pontiac, or his father a comfortable Buick?) And bad as the first-quarter sales figures are, they understate the degree to which consumers generally shop elsewhere. Analyst Steve Girsky of Morgan Stanley estimates that low- or no-profit sales to GM employees, relatives, retirees, and suppliers, as well as to fleet buyers, account for nearly one-third of all the company's car sales.

Wagoner has mapped out a tough road for himself. Most companies, when confronted with continually shrinking market share, reduce their cost base accordingly. Indeed, most observers believe that GM has too many employees, too many dealers, and too many brands for its current level of sales. Consider: While Toyota's three brands--Toyota, Lexus, and Scion--account for fully 13% of the U.S. vehicle market, six of GM's brands--Cadillac, Buick, Pontiac, Saturn, GMC, and Hummer--add up to only 10%.

But Wagoner argues that GM needs to get bigger, not smaller, to support its enormous fixed costs. The expenses for operating its plants and equipment are relatively constant, because union contracts make the factories difficult to close when they are underused. The same thing goes for its active and retired workers--their wages and pensions are fixed by union contract. One reason that GM limps along today is that it has only about one active worker for every 2.5 retirees--420,000 retirees in all. When revenues slide, as they did in the first quarter, the fixed costs obliterate GM's profit.

So any discussion of restructuring, brand elimination, or workforce reduction isn't on Wagoner's list of talking points. The only substantial change he announced involved sales strategy. He had bet heavily on incentives after 9/11 to keep GM's factories full and dealers' lots empty. But now he admitted that the strategy's "incremental effectiveness has eased off." Henceforth, he said, GM will emphasize selling the car, not the deal.

Meanwhile, Wagoner is content to chip at GM's cost structure and ride the attrition curve of its workforce by letting people retire without replacing them. In the long run, Wagoner is counting on a rise in the number of licensed drivers over the next decade to lift the size of the industry.

Nor does Wagoner have much maneuvering room on the No. 1 GM cost bogey: health care. Like all of corporate America, GM is seeing an astronomic escalation in health care costs, but GM's problem is far worse because of benefits it has lavished on members of the United Auto Workers. Unlike almost any employees anywhere, UAW members contribute nothing toward health insurance, have only minimal deductibles, and fork over tiny co-pays for office visits and prescriptions. Retiree health care alone will cost GM $5.3 billion this year--up $1 billion from a year ago. That's nearly 5% of the company's North American revenues.

Wagoner blames that rise for effectively eating up GM's productivity improvements. Yet he never publicly raises the subject of union givebacks, as other companies have, or of reopening the contract, which doesn't expire until 2007. Asked about this in March, all he would say was, "We're going to try to work with the UAW. We can make a lot of progress with cooperation." Charging each retiree $100 a month more for health care would save the company $500 million a year. Wagoner is due to meet with union officials in mid-April.

Life for GM will get harder in the coming months, as weaning buyers from cash incentives will likely punish sales. Nor is it easy to foresee GM's growing much stronger in the long run. What the company needs more than anything are a few smash hits, like the original Chrysler minivan or the Ford Taurus, which will reestablish GM as a leader again. Wagoner is now pinning his hopes on the redesign of the Suburban and other large SUVs. But the new models won't reach market until the first quarter of 2006, and with interest rates and gasoline prices going up, they are unlikely to be as successful as their predecessors.

Despite his setbacks, Wagoner's job seems safe for now. His energy and persistence would make him a superstar running just about any other company. His biggest shortcoming is his inability or unwillingness to make the grand gesture--a deal with the UAW, a public firing, a technological breakthrough--that would galvanize the company and capture the public's imagination. But if GM were easy to fix, the job would have already been done. Combining operations with a Honda or BMW, for instance, would provide an enormous boost, but each company has opposed merging with a stronger partner in the past, and neither would be willing to take on GM's legacy obligations.

A decade ago John Smale, the retired Procter & Gamble CEO who served as GM's nonexecutive chairman, declared that the job of GM's CEO wasn't to boost the stock price or return shareholder value. Rather it was to "sustain the enterprise." The implication was that GM's true mission is to provide jobs for its employees, business for its suppliers, cars for its dealers, and pensions for its retirees. Given the recent events, that may be the best that the company can hope for. Shareholders will have to decide whether to go along for the ride.

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