By Erin Chambers

She may be in one of the holiday season's most competitive categories, but toy-shop owner Debi Grymes has found an imaginative way to stand out. Her Baton Rouge (La.) store, The Little House, has a back room where little girls can dress up and throw tea parties like young ladies. They wear white gloves, fancy hats, and feather boas. Sometimes they file out onto the stage that Grymes' husband and son-in-law built and put on a fashion show for moms in the audience.

"Southern women love their children looking good," Grymes says. And those women, her theory goes, will also want to shop while they're in the toy store.

WHIMSICAL APPROACH.   Like many small retailers, The Little House needs every advantage it can get. Wal-Mart (WMT ), which now accounts for more than 30% of toy sales nationwide, opened a superstore less than a mile away earlier this summer, and Grymes, 48, can't help but be a little worried. With half of all toys moving off the shelves during the holiday season, Grymes is approaching her first big test.

Retail expert Bob Phibbs says The Little House is doing everything right to take on the discount giant: It's offering unmatched customer service, a whimsical setting, and truly unique products. Children's tea parties aren't exactly commonplace in Wal-Mart's wide, waxed-floor aisles -- and that's the kind of edge smaller competitors are trying to exploit.

The Little House wasn't always such a vibrant place. The 1,700 square-foot toy store was shabby and outdated when Grymes bought it in 2001, with dark burgundy walls and dusty shelves. "It was nothing I ever did before, but I knew I was supposed to be here," she says.

RISK-TAKERS AND PIONEERS.  Paint was the first task -- she chose minty greens and bright lavenders -- followed by other improvements, like a mural painted by a local artist and a special room for more baby items. The Little House's facelift also rejuvenated the store's bottom line, and revenue has steadily increased. Grymes doubled her October sales this year, raking in $43,000. "And $400 days were good days when I first started," she says.

Phibbs, author of You Can Compete: Double Sales without Discounting, calls the mega-retailers a "wholesale assault" on America and says more independent stores need to follow Grymes' lead by constantly improving -- and taking some chances -- if they want to stay afloat. "They have to be pioneers," he says.

And it's not just the surface that needs attention. Supplying well-trained employees who ask questions to help customers find the right items, as well as offering a selection of unique products "with all the bells and whistles" are what give Main Street shops the advantage, Phibbs explains.

The "specialty toy channel," represents at least 1,500 retailers and $1.2 billion in annual revenue, according to the American Specialty Toy Retailing Assn., a Chicago-based trade group. Executive Director Kathleen McHugh says local shopkeepers literally handpick their merchandise and bring an expertise and focus on quality that's lacking at their much bigger, albeit cheaper, competitors.

SMALL IS BEAUTIFUL.  "Anybody looking for quality toys wants something unique that's going to be of value in education or development, or just great play value," she says. "And they'll go to that independent neighborhood toy store to find it."

One of Grymes' customers drives three hours from Alexandria, La., because The Little House is the only place she can buy Madonna's English Rose line of books and dolls. When that customer rang up $1,500 in purchases on a recent trip (including a $400 pint-size Mercedes replica), Grymes drove the loot home for her to avoid another $800 in shipping costs. "We didn't even think twice about it," she says.

Small retailers depend heavily on toy manufacturers to keep their inventory top-notch. Beastly Buddies supplies handcrafted Halloween costumes only to Little House and other small retailers. BEKA, a St. Paul (Minn.) maker of high-quality wooden blocks and painting easels, has also refused large retailers' requests for orders for years. "They always tried to come in and advise us on how to cut corners and cut costs," says Jamie Kreisman, founder and co-owner of the family-owned BEKA. "That's not how we want to do business."

SUPPORTIVE RIVALS.  Providing knowledgeable, engaging customer service is another way Phibbs believes stores like The Little House win out over the big boxes. One of Grymes' two full-time employees (she also employs four part-time workers) is what she calls "always dressed" with "sassy heels" and perfectly coifed hair. "This girl does fantastic with clothes," says Grymes, who describes her other full-timer as "just a kid herself," who loves to play with the toys as much the diminutive customers.

Call The Little House any afternoon, and you'll understand that Grymes and her toys are beloved, despite her big competitor down the road. As she talks, a birthday party might be in full swing, and you'll hear the playful noise in the background. Then Grymes, in her friendly Southern drawl, might tell a customer who can't find a particular item to try Victoria's, a nearby toy shop -- and her closest competitor-- with an owner that's "just a doll and promised to honor my price."

Unless Wal-Mart starts serving Kool-Aid and crumpets in the back room, the holidays should remain happy at The Little House.

Chambers is a reporter for BusinessWeek Online in New York