Joseph Diaz is standing in a Wal-Mart in suburban Boston surrounded by "shut-up toys." That's his name for the cheap playthings--93-cent blocks, 88-cent kites--shoppers buy to quiet their kids. But amid the bargain-basement merchandise are a few toys that make Diaz, president of the upscale toy chain Learning Express, a bit nervous. In one aisle he spots Legos at prices 20 percent less than his stores charge. On a high shelf he spies a $97.52 Radio Flyer wagon. "That's a big price point," he says. It'd make a great birthday gift for a grandchild--and a lost sale for Learning Express.

A few years ago every big retailer was struggling to devise a strategy to compete with Web retailers like Lately they're focused on a different threat: Wal-Mart Stores. The chain is already the world's largest company, but its expansion into new regions and product categories is remaking entire industries: as Wal-Mart began deeply discounting holiday toys in recent years, chains like KB and FAO Schwarz filed for bankruptcy. Faced with the same pressure, last week Toys "R" Us announced plans to split its company in half--and may exit the toy business altogether. But not every company in Wal-Mart's bull's-eye will suffer a similar fate. "In almost every category in which Wal-Mart competes, there's at least one competitor that has figured out how to hold their own," says Bain & Co. consultant Darrell Rigby.

To do it, they're finding ways to justify their higher prices by providing more unique products and better service. While Wal-Mart is now America's largest grocery seller, several players--from stores like HEB in Texas to national chains like Trader Joe's--are winning customers by offering fresher food and more variety. Candace Corlett of WSL Strategic Research cites surveys showing customers are less likely to buy hair-care products, cosmetics or clothing at Wal-Mart than they were in 2000; she attributes the shift to specialty stores' working harder to market exclusive brands.

Best Buy thinks it's found its anti-Wal-Mart formula, too. Instead of competing strictly on price, lately the U.S. electronics chain is marketing itself as a sort of concierge, helping customers confused by today's complicated TVs and computer gear. In some cities Best Buy now maintains a "Geek Squad" of techies who'll drive to customers' houses to fix gear. "It's not just whether you buy a plasma TV at Best Buy--it's that you probably want somebody to deliver it and install it," says Best Buy executive VP Phil Schoonover.

Learning Express is adopting a similar playbook. While the chain's 107 stores will stock a few must-haves (like Legos and board games) that discounters sell for less, the company's niche is pricier toys--elaborate building sets and crafts, $180 tricycles--that Wal-Mart won't carry. Stepping into a Learning Express in Sudbury, Massachusetts, Diaz shows off racks of plastic "birthday buckets" hanging behind the cash register; the boxes let kids put in layaway toys they hope their friends will buy for birthday parties. All its stores offer free gift-wrapping; at some locations, busy moms phone in orders and the staff walks a wrapped gift right out to her car. Store owner Tim Hayes picks up a toy balloon pump and sends a latex missile soaring noisily over customers' heads. "You can't compete [with Wal-Mart] on price," Hayes says, "but what I do better is starting to pay off."

Amid scary talk of Wal-Mart's march toward world domination, that optimism is refreshing. Companies like General Motors and Sears once seemed nearly as unstoppable as Wal-Mart, but they later endured tough times. Lately Wal-Mart has faced sex-discrimination lawsuits, a federal investigation over its use of immigrant labor and rising pressure from union organizers. Experts believe it will inevitably stumble, too. For companies forced to battle Wal-Mart, that's good reason not to surrender.