The 89-year-old Rochester-based chain is that rare breed: a grocer beloved by its employees--and one that is also trouncing its competitors in a very tough industry. Here's how the company does it.

(FORTUNE Magazine) – THERE'S A NEW NO. 1

SARA GOGGINS WORKS PART-TIME IN A GROCERY store. The blue-eyed 19-year-old attends college in upstate New York, aiming to teach high school history someday. Poor kid, slaving away at a thankless job for some faceless retail conglomerate. But her employer has a face--a ruddy, smiling one, topped with curly auburn hair--and it's right in front of Sara on this snowy mid-December day in the Rochester suburb of Penfield, N.Y., complimenting her on the display she has helped prepare in the store's French-inspired patisserie.

The face of Danny Wegman, president of Wegmans--the best company to work for in America--turns even redder when Sara whips out a picture she took of the two of them earlier this year, which she keeps behind the counter. "I love this place," she tells a visitor. "If teaching doesn't work out, I would so totally work at Wegmans."

Supermarkets aren't often thought of as desirable employers, what with low pay, grueling hours, annual turnover rates that can approach 100% for part-timers, and labor unrest such as last year's strike in California. Wegmans, however--along with the three other grocers on our Top 100 list--does things differently, including the way it deals with employees. The company has proved adept at battling the intractable problem facing grocery stores in this country--that there's no compelling reason to shop there anymore.

Privately held Wegmans--which had 2004 sales of $3.4 billion from 67 stores in New York, Pennsylvania, New Jersey, and Virginia--has long been a step ahead. Its former flagship store in Rochester, opened in 1930 by brothers John and Walter Wegman, featured café-style seating for 300. Walter's brilliant and pugnacious son Robert, who became president in 1950, added a slew of employee-friendly benefits such as profit-sharing and fully funded medical coverage. When asked recently why he did this, 86-year-old Robert leans forward and replies bluntly, "I was no different from them."

Robert is chairman now; his son Danny, a sartorially challenged Harvard grad who came back to Rochester to cut meat for Wegmans, took the reins in 1976. Early on, Danny was keenly aware of the threat posed by nontraditional grocery outlets like club stores and discounters. (His 1969 senior thesis ended with these prophetic words: "The mass merchandiser is the most serious outside competitor to ever face the food industry.")

In 2003 those nontraditional grocers had 31.3% of the grocery market, and industry guru Bill Bishop projects that number will grow to 39.7% by 2008. That's because consumers think traditional grocers don't offer anything special; 84% believe all of them are alike, one survey has found. Most grocers responded to the competition by slashing prices, wreaking havoc on already razor-thin margins. From February 1999 through November 2004, the four largest U.S. grocery chains (Albertson's, Kroger, Safeway, and Ahold USA) posted shareholder returns ranging from --49% to --78%. Winn-Dixie Stores was booted out of the S&P 500 in December for its horrendous performance.

You don't see such problems at Wegmans. While it has no publicly traded stock, its operating margins are about 7.5% (the company will not disclose net margins), double what the big four grocers earn and higher even than hot natural-foods purveyor Whole Foods. Its sales per square foot are 50% higher than the $9.29 industry average, FORTUNE estimates, thanks to a massive prepared-foods department featuring dishes that rival those of any top restaurant. (Wegmans asked famed Manhattan chef David Bouley for input.)

Each of the newer Wegmans stores is 130,000 square feet--three times the size of a typical supermarket. That means it can offer true one-stop-shopping for every taste. And unlike Whole Foods, which disdains products containing pesticides, preservatives, and other unhealthy stuff, Wegmans stocks both organic gourmet fare and Cocoa Puffs, at competitive prices. That vast selection helps explain why in places like Rochester, Syracuse, and Buffalo, the zeal for Wegmans often borders on kooky obsession. In 2004 the company received nearly 7,000 letters from around the country, about half of them from people pleading with Wegmans to come to their town. Ann Unruh, 52, an insurance manager in Sparks, Md., who has never set foot in a Wegmans, is so excited about a store opening in her area later this year that she plans to take the day off work to be there. She says there will be no need to visit Whole Foods anymore: "I will just shop at Wegmans."

Each Wegmans store boasts a prodigious, pulchritudinous produce section, bountiful baked goods fresh from the oven, and a deftly displayed collection of some 500 cheeses. You'll also find a bookstore, child play centers, a dry cleaner, video rentals, a photo lab, international newspapers, a florist, a wine shop, a pharmacy, even an $850 espresso maker. "Going there is not just shopping, it's an event," says consultant Christopher Hoyt. In an annual survey of manufacturers conducted by consultancy Cannondale Associates, Wegmans bests all other retailers--even Wal-Mart and Target--in merchandising savvy. "Nobody does a better job," says Jeff Metzger, publisher of Food Trade News.

But the biggest reason Wegmans is a shopping experience like no other is that it is an employer like no other. "You cannot separate their strategy as a retailer from their strategy as an employer," says Darrell Rigby, head of consultancy Bain & Co.'s global retail practice. Wegmans' hourly wages and annual salaries are at the high end of the market (the better to fend off unions). Consider the sous chef at Wegmans' store in the Rochester suburb of Pittsford, the chain's highest-grossing store at well over $2 million in sales per week. His name is Charles Saccardi, and his previous employer was Thomas Keller of the French Laundry, the famed Napa Valley restaurant. People like that don't come cheap.

But salaries aren't the whole story. The company has shelled out $54 million for college scholarships to more than 17,500 full- and part-time employees over the past 20 years. It thinks nothing of sending, say, cheese manager Terri Zodarecky on a ten-day sojourn to cheesemakers in London, Paris, and Italy. (It's no doubt easier to pamper employees like this when you don't have Wall Street breathing down your neck; a third of FORTUNE's best companies to work for, like Wegmans, are private.) Even Wegmans is not immune to economic realities, however. Back in August 2003, the company--which previously covered 100% of employees' health insurance premiums--asked salaried employees earning more than $55,000 a year to contribute to the cost. This month Wegmans began asking all other employees to pony up too.

All that means Wegmans' labor costs run between 15% and 17% of sales, Bishop estimates, compared with 12% for most supermarkets (the company declines to comment). But its annual turnover rate for full-time employees is just 6%, a fraction of the 19% figure for grocery chains with a similar number of stores, according to the Food Marketing Institute. Almost 6,000 Wegmans employees--about 20%--have ten or more years of service, and 806 have a quarter-century under their belts. The supermarket industry's annual turnover costs can exceed its entire profits by more than 40%, according to a study conducted by the Coca-Cola Retailing Research Council. When you understand that, you begin to see the truth in Robert Wegman's words: "I have never given away more than I got back."

The proof is in the stores every day. The smiles you receive from Wegmans employees are not the vacuous, rehearsed grins you get at big-box retailers. They are educated smiles, with vast stores of knowledge behind them, cultivated perhaps through company-sponsored trips to Napa Valley's Trinchero winery. After all, what good is it to offer 500 types of specialty cheeses if you can't explain the origin of each, what type of cracker to serve them on, even what wines they should be paired with? "If we don't show our customers what to do with our products, they won't buy them," says Danny Wegman. "It's our knowledge that can help the customer. So the first pump we have to prime is our own people."

Priming the pump starts early. More than half of Wegmans store managers began work there as teens. "When you're a 16-year-old kid, the last thing you want to do is wear a geeky shirt and work for a supermarket," says Edward McLaughlin, director of Cornell's Food Industry Management Program. But at Wegmans, "it's a badge of honor. You are not a geeky cashier. You are part of the social fabric."

A cashier making $5.93 an hour part of the social fabric? But it's true. Wegmans employees don't work in any old supermarket. They work at Wegmans, and there's cachet attached to that. You're a culinary whiz, an ambassador of fine cuisine--even if you only stock shelves at night. "Just about everybody in the store has some genuine interest in food," says Jeff Burris, who runs the wine shop at Wegmans' Dulles, Va., store. In fact, Wegmans has been known to reject perfectly capable job candidates who lack a passion for it.

Not all Wegmans cashiers are food connoisseurs, but a common denominator of passionate customer service sets Wegmans workers apart from those at other retailers. Simply put, no customer is allowed to leave unhappy. To ensure that, employees are encouraged to do just about anything, on the spot, without consulting a higher-up. One day it could mean sending a chef to a customer's home to clear up a botched food order. It could also mean cooking a family's Thanksgiving turkey, right in the store, because the one Mom bought was too big for her oven. Is that expensive? Sure. Is it worth it? You bet. A Gallup survey found that over a one-month period, shoppers who were emotionally connected to a supermarket spent 46% more than shoppers who were satisfied but lacked an emotional bond with the store.

Empowering employees goes beyond making house calls, though--it also means creating an environment where they can shine, unburdened by hierarchies. Kelly Schoeneck, a store manager, recalls the time a few years back when her supervisor asked her to analyze a competitor's shopper- loyalty program. She assumed her boss would take credit for her work. But no: Schoeneck wound up presenting her findings directly to Robert Wegman.

That ethos exists at all rungs of the corporate ladder. For example, the Pittsford store sells "chocolate meatball cookies" made from a recipe passed down to Wegmans bakery employee Maria Benjamin from her Italian ancestors. About 15 years ago, Benjamin, who had been baking the cookies for other employees, persuaded Danny Wegman to sell them. How? She just asked him. "They let me do whatever comes into my head, which is kind of scary sometimes," says amiable part-time meat department worker Bill Gamer. Says operations chief Jack DePeters, only half- jokingly: "We're a $3 billion company run by 16-year-old cashiers."

Wegmans can save some serious coin by encouraging employees to step up to the plate. When the company opened a new, $100 million distribution center in Pennsylvania last June to serve its newer Mid-Atlantic stores, it needed truck drivers. Rather than hire experienced (and expensive) pros, Wegmans allowed current store employees to apply for the job. Twenty-one weeks later Wegmans had two dozen drivers with commercial licenses; they had previously been cashiers and produce clerks.

The Wegmans culture flows from the top: from Robert, Danny, and his two daughters, SVP of merchandising Colleen (33 and the likely heir) and 30-year-old group manager Nicole. But there is no shortage of folks to act as cultural conduits for new hires as the chain expands beyond its Rochester roots. (The company's expansion is slow and methodical: It generally opens only two new stores a year. In 2005, one is opening in Fairfax, Va., and one in Hunt Valley, Md.) The new stores may be tougher for the family to keep tabs on. But the Wegmans culture "is bigger than Danny in the same way that Wal-Mart's became bigger than Sam [Walton]," says Bain & Co.'s Rigby.

Wegmans guarantees that by populating new stores with the best and brightest from existing ones, a strategy that wouldn't work if the company were pursuing a more aggressive rollout plan. Take the Dulles store, which opened last February (it drew 15,500 shoppers on its first day, more than most supermarkets get in a week). All its managers came from different Wegmans locations--and that doesn't include the dozens of employees from other stores who jetted in temporarily to get the place up and running. Wegmans spent $5 million on training alone in Dulles. The company never opens a store until its employees are fully prepared. The Dulles store could easily have opened in November 2003 for the critical holiday-sales season, but Wegmans chose to wait until the following February. How many retailers would do that?

The emphasis on development over dollars attracts people who never thought they would work in retail, much less in a grocery store. Consider Heather Pawlowski, 38, an electrical engineering major at Cornell who began her career at National Semiconductor. "I was a techie," she recalls. But she had always enjoyed walking the aisles of retailers and wondering why people bought different brands. And in Rochester, what better aisles are there to walk than Wegmans'? So as a newly minted MBA, she entered Wegmans' store manager training program. While her classmates were off to Wall Street, she wore long underwear and got up to her elbows in fish guts. As she moved from packing fish to cutting meat to baking bread, learning all aspects of store operations, Pawlowski was amazed by how much time the store manager spent with her, talking about how things worked at Wegmans.

When asked what makes Wegmans tick, Pawlowski, now a vice president, replies, "We're taking customers to a place they have not been before." And once they arrive, shoppers often don't want to leave. Longtime customer Toni Gartner, 61, is spending the winter in Florida for the first time. But all things being equal, she'd rather be back in frigid Buffalo. "I am trying to get used to Publix," she says. "I understand that Publix is rated highly. Maybe--but it ain't Wegmans."