Beat The Beast
How small businesses are competing against the big chains—by using their WITS AS THEIR SLINGSHOTS.
By Joshua Hyatt

(FORTUNE Small Business) – Wake up and sell the coffee: that was the message that entrepreneur Mike Sheldrake got a few years back when he concluded, "I was going to have to either do something radical or close my doors." His 22-year-old business, Polly's Gourmet Coffee in Long Beach, Calif., was under attack by Starbucks. Sheldrake had ignored the opening of a Starbucks nine blocks away, even though the chain outlet quickly proved popular. Sheldrake's 1,700-square-foot store, which had been stirring up $1 million a year in revenues, saw sales drop by more than 5% a month, until he was losing money on sales of $800,000. Then when another Starbucks opened, only 78 yards away, "I was just kind of lost," says Sheldrake, 57.

Sheldrake has since found his way. Polly's is now netting around 15% pretax profit on annual revenues of $1.1 million. The competition didn't go away. In fact, Sheldrake now counts 11 businesses selling coffee within 900 yards of his own. But he has figured out how to make his business stand out, especially in its look and service. He had to retrain employees (to greet regular customers by name, among other things) and add performance incentives to their compensation. He placed an eye-catching 1929-vintage coffee roaster at the store's center. And in many small ways—selling warm beans right out of the roaster, for instance—he learned to get better at what he does. "A lot of these steps are things that I should have been doing anyway," he admits.

That is a common refrain among small retailers that are successfully battling a beast, be it Starbucks or Home Depot or Wal-Mart. In some industries independents are showing renewed signs of life amid the big-box blitz. Choose any retail category and you will find that the entrepreneurs who are thriving in the shadow of the giants are embracing several common strategies:

•They focus on a niche in which they can excel and to which their big competitors, for all their savvy and economies of scale, can't devote as much attention.

•The winning small companies make themselves distinctive, in fact and in image, to appeal to customers who see themselves as independent thinkers and yearn to shop outside the big box.

•They provide convenience and friendly, well-informed service, often along with an element of theater (like the Florida appliance store that encourages customers to bring in their laundry and do a load in one of the washing machines).

"People want to support the independents," says Bob Phibbs, a Long Beach--based retail consultant who helped Sheldrake. "You just need to give them a better reason to shop at your store." While there are common themes, the formula for success is different for each small business. As you read about the entrepreneurs in the pages ahead, you will notice how vigilant they are—say, by checking their prices against the competition's and looking for ways to tweak the experience they offer their customers. "Nobody can beat you on the relationship you have with your customers," says Wally Bock, a retail consultant based in Wilmington, N.C. "In most of the communities where you get weeping and wailing about the coming of a Home Depot, you'll find stores that were habitually giving crappy customer service." That may sound harsh, but it is a lesson well learned by entrepreneurial Davids who are winning against their Goliath-sized rivals all over the country. —JOSHUA HYATT

UMBER: DETAILS MATTER

UMBER'S ACE HARDWARE Fort Wayne

OWNER: DAVE UMBER KEY STRATEGY: Long-term, obsessive attention to detail—and careful spying on rivals ANNUAL REVENUE: $3.25 mil. ANNUAL GROWTH RATE: 4% TOP RIVALS: Home Depot, Wal-Mart, Lowe's, Menards

It was hard for Dave Umber to admit he needed help. Sitting in the living room with his wife and parents last summer, Umber shared a serious problem he was having: His three hardware stores in Fort Wayne had together lost $110,000 in the previous two years. The giant superstores and home centers were chipping away at his sales. That night Umber opened his books and, with input from his family, made a plan that quite possibly saved his business. He ended up breaking even last year, and sales were up 4% by mid-2004.

That is no small feat, given the competition he is facing. In the past decade or so, Fort Wayne (pop. 200,000) has become home to two Home Depots, two Menards (a Midwestern chain of home superstores), three Lowe's, and three Wal-Marts. Each time one of them opened, the customer count at Umber's nearest store fell at least 10% for the next year. The majority of customers eventually come back for at least some of their supplies, but some don't. "You keep working a little harder and a little harder, and yet you see profits slowly eroding," says Umber, whose per-store sales total $1 million to $1.5 million. Adding pressure, he is the third generation to run Umber's Ace Hardware since his grandfather founded the first store in 1944.

His formula for thriving in the shadow of the giants isn't a quick fix but rather a long-term, obsessive attention to detail. Step one for Umber was to trim expenses. Successful hardware retailers, he learned from consulting Ace, a coop of some 5,000 stores, spend no more than 20% of earnings on payroll. He was spending 25%. To get his numbers in line, he needed to lay off three senior supervisors. "I had to walk up to people who've been employees of mine for years and say, 'I've got to let you go. You're a great person, but I can't afford to pay you anymore,'" says Umber. "It was hard." At the same time, he stepped back into the role of managing one of his stores. He also scaled back health benefits for his 12 fulltime employees and eliminated bonuses. He changed accountants, finding one who would give him the monthly financial reports he had been doing himself. His advertising budget dipped from $120,000 to $100,000. Extras such as his supper club membership evaporated. He cut his lighting bill by $500 a month with energy-efficient fluorescent bulbs. Small savings, perhaps, but in a business that aims to make 3 pennies of profit on a $1 sale, every bit counts.

Umber also stocks products and offers services that many of the big boxes don't, such as smaller cans of paint thinner and chain by the foot, along with free delivery. After conducting one of his annual exit surveys, Umber learned that his customers were interested in bird feeders. Two weeks later he had 24 feet of shelving devoted to them. He also stays in tune with the community: At science-fair time he stocks extra bell wire, batteries, mousetraps, springs, and magnets. When the Cub Scouts hold their annual Pinewood Derby, he has not only graphite lubricant at the ready but advice as well: "We'll show them the best way to weight the wood," he says. "I'll even pull out my son's car from a few years ago and show them."

Still, the biggest challenge for any independent fighting superstore competition is pricing. Umber's rule of thumb is to keep his prices within 10% of the competition's. His windshield wiper fluid is $1.19. Wal-Mart's is 94 cents. His 20-pound bag of Kingsford charcoal is $7.49, Wal-Mart's is $6.27. (Prices change seasonally.) "For 80% of the items I sell, nobody has any idea what they should cost anyway," says Umber. "If it's the difference between $1.09 and $1.29, customers don't care, particularly if it saves them from having to run across town to Home Depot. But if something is $10 more, they will."

Because Umber buys 90% of his inventory through Ace, he can remain competitive on price and also know which products sell best nationally. Virtually all independent hardware stores buy from a major supplier, whether a co-op such as Ace or True Value, or a wholesaler such as Orgill. The co-ops also provide advice on what works for other members and, for around $2,500 a month in Umber's case, national advertising of the Ace brand. Although the number of independent hardware stores has fallen from 24,450 in 1975 to 20,200 today, the shakeout seems to be over: The National Retail Hardware Association forecasts 5% annual sales growth among independents over the next five years.

By now Umber is so used to seeing a big-box rival open every nine months or so that he keeps his stores ready, freshly painted and waxed. Just before a new competitor opens shop, "I'll do heavier promotion to remind people we've been here for a long, long time, and we've got some good deals," says Umber.

How does he know his deals are competitive? Umber regularly walks the bright open aisles of his local superstores with a pad and pencil, checking the prices. He hasn't yet been kicked out for snooping, although one of his managers has. Checking out toilet parts at Home Depot one Monday morning, Umber bumps into Tim Stinson, a longtime customer, who asks, "What are you doing here?"

"I'm spying on the competition," Umber says with a smile. "What are you doing here?"

"Well, there are things on my list that you just don't have," says Stinson, citing Rustoleum chalkboard paint. But Stinson says he prefers to shop at Umber's Ace, where "people help you a lot quicker. I know if I buy a shovel there, and it breaks, all I have to do is bring it back and he'll replace it, no questions asked. Here you've got to find someone to help you and fill out lots of forms. And at Ace they always have a big smile."

"Nice to see you, Tim," says Umber, shaking his hand to leave. "See?" says Stinson. "Nobody at Home Depot knows my name." —JULIE SLOANE

RENY'S: GOING SOFT

RENY'S Newcastle, Maine OWNERS: ROBERT AND JOHN RENY KEY STRATEGY: Shrewd positioning into soft goods—and away from Wal-Mart ANNUAL REVENUE: $45 million ANNUAL GROWTH RATE: 6% TOP RIVAL: Wal-Mart

We were scared," admits Robert Reny, 50, referring to the time Wal-Mart first ventured into Maine. Along with his brother, John, 52, Robert runs Reny's, a 450-employee chain of 14 department stores founded by their father, Robert Sr., 78, in 1949. From their headquarters in Newcastle, the siblings together studied Wal-Mart's positioning and tactics and shopped its stores, looking for ways to differentiate themselves from the retailing giant.

At the time—about ten years ago—the Renys concluded that Wal-Mart had a lock on "hard" goods, but that it was vulnerable in "soft" goods (clothing and shoes), which now account for roughly half of the Reny's chain's $45 million in annual sales. "In clothing Wal-Mart sells whatever is inexpensive," notes John Reny. By upgrading Reny's clothing mix, the brothers aimed to maneuver around the giant retailer.

Their two-pronged strategy relied heavily on their company's nimbleness. First, they emphasized higher-quality brands, such as Columbia, Timberland, and Woolrich, at still-reasonable prices. While once a top seller of Dickies clothing, Reny's has now become one of Maine's largest carriers of Carhartt workwear, a higher-end brand—and one not carried by Wal-Mart. Still, they remained sensitive to price. "We try to be a little bit below the market and accept a little less margin," John notes.

At the same time, the brothers gobbled up small lots of closeouts, irregulars, seconds, and production overruns from those same better-quality, name-brand apparel makers and aggressively marked down the prices. They knew that Wal-Mart, dealing with much larger volumes and uniform merchandise, simply could not engage in such guerrilla retailing.

Last year Reny's scooped up and sold 30,000 pairs of fleece-lined jeans and 5,000 children's winter jackets, selling each item at $20. Bought directly from the factory, the items came via production overruns from a competing retailer that was selling the jeans at $40 and the jackets at $60.

The strategy has paid off. The first year after Wal-Mart's arrival, Reny's annual growth dropped from 8% to zero. But it edged up to 3% the next year, and since then it has doubled to 6%. Despite Wal-Mart, Reny's has remained profitable. It recently completed a 90,000-square-foot office, warehouse, and distribution complex to better compete with—who else?—Wal-Mart. —ED WELLES

THE MUDTRUCK: SELLING PRICE

THE MUDTRUCK New York City

OWNERS: GREG NORTHROP AND NINA BEROTT KEY STRATEGY: Low prices and local flavor ANNUAL REVENUE: $520,000 ANNUAL GROWTH RATE: 77% TOP RIVAL: Starbucks

It is a cool and rainy morning in New York City, and Cheryl Petit de Mange wants a cup of coffee. Two big, bright Starbucks shops beckon from 200 yards in either direction. But Petit de Mange instead joins 14 other hardy java junkies crowded around what looks like a bright-orange ice cream truck. She's waiting to buy a 12-ounce cappuccino for $2—$1.68 less than what she'd pay across the street. "It's not just about price or better customer service," yells Petit de Mange over the soul music blasting from the truck's sound system."Why would you go to Starbucks when you can support a neighborhood business like this?" She has just summed up how a pair of entrepreneurs, equipped with nothing more sophisticated than a refurbished electric-company truck, keep their coffee business percolating despite being sandwiched between two outlets of a popular and respected national chain.

Everything Mud founders Greg Northrop and Nina Berott do is designed to distinguish their business from Starbucks and other national brands. "My profit margins probably aren't as great as Starbucks," concedes Northrop, 40, who says he could make a "decent profit" if he weren't putting so much of his earnings back into the business. Northrop wants to boost sales, which grew to $520,000 last year, up from $293,000 in 2002, the year he added a second truck now on Wall Street.

Three years ago, after outfitting their truck with a cappuccino maker, three sinks, and a diesel-powered generator, Northrop and Berott parked it next to one of lower Manhattan's busiest subway stops: Astor Place. Even in the East Village, which styles itself as too cool to notice, the truck manages to draw gawkers with its loud, upbeat music (from local bands, of course) and poster-sized want-ads that Mudtruckers, as regulars are called, put on the truck's side when they're looking for a place to live.

Mudtruck has six servers. Rather than invest in formal training, Northrop tries to hire ex-bartenders, figuring that they're likely to be better attuned to customers' moods. "They're upbeat—they give off a better vibe than the corporate chains," says customer Sean McArdle. But much of the coffee's appeal boils down to something simpler. "The real reason I drink Mud is because it's cheap," says freelance writer Mike Malone, a Mudtruck devotee. Mudtruck can charge less because Northrop pays no rent and is open only from 7 A.M. to 5 P.M. six days a week. Northrop prides himself on serving up a strong blend. "Let me put it this way: We're not ripping you off," he says.

If it sounds as if he's making an unflattering comparison to the national chains—well, he probably is. For its part, Starbucks takes the high road. "We welcome any competition," insists spokesman Alan Hilowitz. And Northrop is determined to bring it. Last September he launched his company's first storefront cafe, Mudspot, just a block from another downtown Starbucks. It's a place where Mudtruckers can relax, admire one another's artwork, and drink out of a local potter's mugs. He's "focusing on the needs of the locals," as Mike Ferguson, spokesman for the Specialty Coffee Association of America, puts it. That strategy has helped boost the number of independent coffeeshops from 8,500 in 2001 to 10,000 at the end of 2003, according to Chicago-based research firm Mintel. That happens to be the same number of stores that Starbucks plans to have open by 2010. —MAGGIE OVERFELT

WATERLOO: ENLISTING ALLIES

WATERLOO RECORDS & VIDEO Austin OWNER: JOHN KUNZ KEY STRATEGY: Teaming up with other independents ANNUAL REVENUE: $6 million ANNUAL GROWTH RATE: 8.5% TOP RIVALS: Borders, FYE

In the mid-1980s, when John Kunz heard that a huge Wherehouse Records was opening across town, he restocked the inventory and increased the marketing budget at Waterloo Records & Video, the small store he owns in downtown Austin. He took the same steps in 1990 when Tower Records moved in a mile away. But two years ago, when he found out that the city was going to pay $2.1 million to help build a Borders right across the street, he decided to enlist the help of other local businesses. "It was time to galvanize the community into stopping the malling of America," says Kunz, 53.

Building alliances with like-minded independent businesses has enabled Waterloo not only to survive but to grow, despite the rising challenge of well-run and well-financed national rivals—such as Barnes & Noble and FYE, which are both nearby. In a hypercompetitive market where some big music retail chains have gone bankrupt—Austin's Tower Records outlet closed in mid-June—Waterloo has been growing revenues at an average of 8.5% a year, to more than $6 million in 2003.

Kunz likes to think that is partly because of the business group's "Keep Austin Weird" campaign, an outgrowth of the earlier fight against Borders. Once the giant became a threat, Kunz's was the second company to join the city's oldest and most eclectic stores in forming the 150-store Austin Independent Business Alliance. The idea was to promote one another's stores, buy supplies from one another, and launch a bumper-sticker marketing campaign illustrating the benefits of buying locally: According to an economic report that Kunz helped commission in late 2002, only $13 of every $100 spent at Borders would circulate back into the local economy—compared with $45 at Waterloo. (Borders, which has two other stores nearby, did not return our calls.) That report was e-mailed to customers, members of the city council, and local reporters. In April 2003, before breaking ground, Borders canceled construction of its Austin store. A spokesperson for the company blamed the decision on a weakening economy.

Kunz counts on another alliance to help him run Waterloo's daily operations. In 1995 he helped found the Coalition of Independent Music Stores, a national network of 70 small, locally owned stores that helps them buy, stock, and promote new music. Waterloo lures customers by hosting 115 free shows a year. "We give music lovers something the chains have lost sight of," says Kunz. "And that's putting music first." —M.O.