The Fiero was conceived as a small, two-seat sports car with all new suspension and a V6 engine. While General Motors's management were opposed to invest in a second two-seater sports car that might compete with the Corvette, young Pontiac engineers in 1978 were able to sell the Fiero concept to the corporation as a fuel-efficient four-cylinder "commuter car" that just happened to have two seats, rather than a muscle car. When the engineers brought back a running prototype in less than six months, it was given the green light for production. They perceived the oil crisis as a market opportunity for a fuel-efficient sporty commuter car. The Fiero was redesigned to use a fuel efficient version of GM's 2.5 L (151 cu in) four-cylinder Iron Duke engine capable of 31 mpg‑US (7.6 L/100 km; 37 mpg‑imp) in the city and 50 mpg‑US (4.7 L/100 km; 60 mpg‑imp) on the highway with the economy-ratio transmission option. The fuel economy was considered as impressive for a 2.5 L engine of the period, but the three-speed automatic reduced highway mileage to only 32 mpg‑US (7.4 L/100 km; 38 mpg‑imp). With respect to fuel economy, the Fiero was intended to appeal to a market niche for which the Corvette with its V8 engine was unsuitable.
The Fiero turned out to be an unusual design for GM, one which stood out from the rest of their product lines. However, the budget for the car, from design to retooling of the plant, was 400 million dollars, just a fraction of what GM generally spent on bringing a typical prototype car into production. Pontiac assigned oversight of the Fiero project to Hulki Aldikacti, a Turkish born executive with nearly 22 years of experience.
As the prototypes took shape, the exterior lines resembled more of a Ferrari or Porsche than a typical GM car, but the tight budget was taking its toll on the design, particularly on Aldikacti's dream of a high-performance, aluminum-block V6; the cost of developing a new engine would be more than the production of the whole car itself. Instead, Aldikacti was forced to settle for the already manufactured four-cylinder engine GM produced for the Pontiac, the "Iron Duke," nicknamed for its heavy iron block. This engine was too blocky to fit into the tiny car so it was equipped with a smaller oil pan, causing the engine to run on less oil than it was originally designed for. Another issue was weak connecting rods that would shatter, blowing pieces through the engine block and dumping oil on hot exhaust components.
A mid-engine layout was originally chosen as a way to reduce both aerodynamic drag and vehicle weight to improve fuel efficiency, and also for its handling, traction, and braking benefits. However, the performance potential of the mid-engine layout was not realized when the Fiero debuted. As a cost-saving measure commonly employed at GM at the time, the tires, brakes, and suspension components were carried over from other GM platforms such as the X and T platforms. As a result, the handling abilities of the Fiero were merely on par with other contemporary sporty coupes (Road & Track 1985). Additionally, the Iron Duke engine, which was designed for optimal running at low RPM, was unsuited to drivers who purchased the Fiero expecting a quick, high-revving motor keeping with the design of the car. As drivers attempted to frequently run the engine at greater RPM than it was designed for, the engines experienced a number of reliability problems and breakdowns were frequent.
The public had high expectations for the Fiero with its mid-engine layout and aggressive styling, which resembled exotic mid-engine sports cars like the Ferrari 308GTB. While initially garnering good reviews for its handling (Motor Trend 1984), the Fiero soon received negative reviews from other automotive critics who expected higher performance from a mid-engine two-seater. Despite the criticism, the Fiero sold well and although Pontiac operated three shifts at the factory during 1984, they could not keep up with initial demand.
The sharing of suspension and other components with other GM cars meant the rear suspension and powertrain was virtually identical to that of the Phoenix; the Fiero even included rear tie rod ends attached to a "steering knuckle", although these were hard-mounted to the engine cradle and only used for maintaining the rear tire alignment. The front suspension was derived from the Chevette.
By 1985, the oil crisis was over and demand developed for a Fiero having more engine power and better performance. Pontiac responded by introducing the GT model which included upgraded suspension tuning, wider tires, and a V6 engine having 43 hp (32 kW) more than the base four-cylinder.
Finally in 1988, numerous changes were made to the Fiero to bring it in line with its original design. The most significant was a completely redesigned suspension (and parts of the space frame) to realize the potential of the mid-engine layout. The unique suspension included new two-piece brake calipers and upgraded brake rotors. These had been part of the Fiero's initial design, but cost-cutting kept them from being implemented sooner. The available I4 and V6 engines benefited from evolutionary improvements, but the planned availability of turbochargers and newer DOHC engines did not happen before production stopped. In spite of the much-improved car which finally had realized its potential after years of mismanagement, GM ended production after the 1988 model year due to declining sales figures. Bad press and consumer sentiment frequently cited heavy media coverage of Fiero engine fires, as well as the poor reliability and performance of the 1984–1987 models.