(FORTUNE Small Business) – Located in sleepy Waitsfield, Vt. (pop. 1,525), Small Dog Electronics hardly seems a company likely to survive a brutal, industrywide shakeout. On any given day as many as 18 of its employees' dogs roam the hallways, plop on comfy sofas, or lounge in dog beds under workers' desks. CEO Don Mayer, 55, and his 32-year-old son and partner, Hapy, shower workers with costly perks such as free weekly massages, guaranteed personal loans from a local bank, profit sharing, and health insurance for their pooches. On days when business is slow, workers are free to hike trails or ski—on the clock. As part of the company's commitment to social responsibility, Small Dog donated $25,000 last year ($16,000 of which came from customers' matching gifts) to nonprofit organizations its employees chose, among them Planned Parenthood and Puppy Mill Rescue, a canine-rights organization.

But Small Dog, the largest reseller of Apple Computers in New England, is operating in a difficult market. Apple has opened a chain of retail stores, creating a tough new competitor for the small Vermont firm. On top of that, Small Dog, facing tight supplies, last year suddenly slipped into the red for the first time since Don Mayer founded it in the bedroom of his home in 1994 with his savings and credit card loans. An obvious quick fix would have been to cut wages, benefits, or charitable contributions. Mayer refused.

Why? The CEO knows that his competitive edge, the attribute that made him a leading reseller of Apple computers, is great customer service. And the best way to get that is to treat his 26 employees the way he'd like them to treat his customers. Small Dog staffers are as loyal as their pets, up-to-date on the latest Apple technologies, and willing to work round the clock to please customers. The company's service reps are so knowledgeable that Apple has turned to them with questions that have stumped its own technical support people, says Don Mayer. (FSB's attempts to confirm this with Apple were unsuccessful.)

Don Mayer—who likes to ride to work on his motorcycle with his Pomeranian, Fantail Shrimp, strapped into a special harness—also counts on his employees to make customers feel that they are part of the warm and fuzzy Small Dog family. It's an approach that often generates repeat business. On the company's quirky website, where it pulls in most of its sales, employees encourage people to join in the fun. So far more than 1,800 customers have posted pictures of their dogs on the site's Dog Friend Index. "You can buy computers anywhere—even from Apple," says Don Mayer. "What sets us apart is our people. They're smart, they know technology, and they will go the extra mile for the customer."

So as they struggled to restore profitability last year, the father-and-son team didn't want to risk losing any of Small Dog's talent by tampering with its unique workplace atmosphere. "Hiring and retraining costs real money," explains Don Mayer. Instead they explained the financial situation to employees, asked them to redouble their sales efforts, and dipped into the company's cash reserves. The strategy worked. Small Dog is profitable again this year and on track to exceed last year's $25 million in sales.

Not surprisingly, few employees want to leave Small Dog once they join. The company's annual turnover rate last year was 1%, compared with the retail industry's 29%. And Small Dog gets bombarded with job applications from as far away as Pennsylvania anytime there is an opening, allowing it a selection unusual for a small business in a town so small that it is no more than a pinprick on a state map. "This isn't just a company," says Troy Kingsbury, 34, a technology service manager who previously ran a convenience store he owned in town. "This is a family." Most days he's at his desk at 6 a.m. and goes home at 7 p.m. to see his two small children before they go to bed. Sometimes he'll pop back into the office later in the evening for a couple of hours to finish up some work. "I appreciate all the extras we get at Small Dog," says Kingsbury. "As a former small-business owner, I understand that hard work pays for all those benefits."

Mayer, who previously started a successful alternative-energy firm, constantly dreams up new ways to make Small Dog Electronics a better place to work. He says offering the right inspiration—such as a recent two-day deep-sea-fishing trip or an upcoming jaunt to a curling convention—is the most important part of his role as CEO: "My job is to figure out how to create a workplace so exciting and rewarding that people can't wait to get up in the morning and come to work." If that costs the company a bit extra, so be it. —PATRICIA B. GRAY