April 24, 2008: 1:42 PM EDT
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Finished celebrating? Now get back to work

Ford's surprise profit is good news but doesn't presage smooth sailing in the future. Here's why.

By Alex Taylor III, senior editor

Ford CEO Alan Mulally has taken only the first step in a long road to recovery for the automaker.

NEW YORK (Fortune) -- Black ink is always better than red ink, and Alan Mulally and his team at Ford Motor should pat themselves on the back for their first-quarter performance. They can thank strong results overseas combined with aggressive cost cuts at home that were sufficient to overcome a turbulent global economy and especially poor auto sales in the United States.

But auto companies don't turn around in one year or even two. They can get a nice bump by reducing operating expenses - there is always plenty of fat to trim and operations to streamline - but making improvements in the top line means introducing new models that require a minimum of four years to make it from the idea stage to the showroom. Mulally has been on the job for just 20 months and has plenty of hard work ahead of him.

If you take a closer look at Ford's financial report, you can find several reasons for worry. And there are others issues that don't appear in the report that are equally troublesome.

1. Ford built 40,000 fewer vehicles in North America during 2008's first quarter than in the first quarter of 2007. Mulally has declared his intention to shrink Ford (F, Fortune 500) to whatever level is required to make it profitable. But the company that invented mass production should know better than anyone that economies of scale require high volume.

2. Ford is continuing to rely on fleet sales in the United States as its retail market share slides. During the first quarter, more than one third of its sales were made to fleets, which erode resale values and produce little or no profit. Ford's retail market share was only 9.8%, compared with 10.1% in the first quarter a year ago. Except for the F-series pickup and the Mustang, few of Ford's products resonate with consumers.

3. Volvo, whose largest market is North America, is losing money. Despite an overhaul of its product line over the past 24 months, it recorded a pretax loss of $141 million in the first quarter, compared with a $94 million profit of a year ago. After demonstrating with Jaguar that it doesn't have a clue about running a European brand, Ford seems determined to repeat the same mistakes all over again.

Dig a little deeper into Ford and you find other problem areas, some of which can be quickly fixed and others for which no easy solution is visible.

1. Mulally has made progress in reducing the infighting at Ford but has created an organizational structure with a built-in potential for conflict. He has anointed three global super-executives for product development, marketing and manufacturing but told them to report to the head of North American operations in addition to himself - a recipe for backstabbing. No similar setup exists in any of the other three regions in the world where the global executives exercise supreme power - and all of those regions, by coincidence, are outperforming North America.

2. Ford is ill-equipped to cope with increasingly stringent demands by the federal government to ratchet up fuel economy. Earlier this week, the government squeezed the regulatory noose a little tighter by proposing that car companies boost their fleet fuel economy 25% by 2015. Except for Chrysler, Ford is perhaps the automaker most heavily weighted in V-8 engines and least proficient in alternative fuels.

3. Although Mulally promises to make Ford profitable by next year, it won't be until 2010, when the subcompact Fiesta and compact Focus launch in North America, that he has a competitive range of small cars to sell. Each bump up in the price of oil must give him cold sweats at night. With its sales of large pickups and SUVs eroding by the day, Mulally will have to vamp for another 18 months until the good stuff gets here.

To date, Mulally has exceeded expectations at Ford. To suggest that he has only picked the low-hanging fruit is to do him a disservice. Quality has improved and Ford's public reputation, as measured by positive press reports, is growing. But as the above should make abundantly clear, he has much left to do. To top of page