The key difference between discounters Target (TGT) and Wal-Mart (WMT) can be summed up in one word: Lingerie.

Anyone who even thinks about heading to Wal-Mart for something saucy should plan on a life of celibacy, stale pretzels and sitcom reruns. But Target offers an exclusive line of sexy lingerie sold under the Gilligan & O’Malley brand.

No one can compete directly with Wal-Mart, the world’s largest retailer and renowned price killer, and Target doesn’t try. Instead, Target has successfully positioned itself as the upscale discounter offering higher quality merchandise that appeals to a younger, better educated and more affluent customer.

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The Dayton Company opened the first Target store in 1962 in Roseville, Minnesota, a suburb of Minneapolis. George Dayton founded the company in 1902 when he opened a store called Goodfellows. Twenty years later, Target expanded to the East and West coasts. It acquired 33 FedMart stores in Arizona, California and Texas and reopened them as Target stores the following year. In 1986, Target acquired 50 Gemco stores and became a major retailer in Southern California. It followed by opening new stores in the Pacific Northwest and the Southeast. The expansion gave Target the clout needed to compete against other retailers nationwide.

Robert Ulrich, who stepped down last year after 23 years with the company, including about 14 as CEO, knew Target couldn't compete with Wal-Mart on price alone. He led the transformation of what was just another Midwestern discounter into one of the world’s most respected companies and one studied in business schools.

“The success of Target illustrates the importance of distinctive communications in achieving long-lasting differentiation on anything other than price,” Patrick Barwise and S. Meehan wrote in Simply Better, a book published by the Harvard Business School Press. “…It is not a niche brand, but through its commitment to design and innovative marketing communications, it has managed to depart sufficiently from Wal-Mart in terms of image and branding to build loyalty among a large and attractive segment of the American population and to grow its business extremely profitably.”

Specialization would have limited future growth, but differentiation meant the chain could coexist and thrive in its sector. That insight moved Target from being just another regional discounter trailing in Wal-Mart’s wake to becoming a long-term winner. In 2002, it passed Kmart, now part of Sears Holdings (SHLD), to become the nation’s second-largest discount retailer. It currently boasts 1699 stores in 49 states and did $64.9 billion in sales last year.

Target has signed partnerships across merchandise lines ranging from apparel to food and kitchenware. In clothing, the company teamed with Mossimo and Alexander McQueen while launching private labels such as Xhilaration, Cherokee and Merona. Each label slices the market in a specific way, and the combination is intended to appeal to a broad range of customers, especially those with money in their pockets. Target says its customers have a median household income of $60,000, or about $20,000 more than the median income analysts say is typical for Wal-Mart’s customers.

Target understood that it wasn’t enough to fill the racks with different labels stitched into the clothes - the company needed to build its name through branding that encompassed both design and advertising.

Analysts say Target outspends Wal-Mart on advertising. Target creates witty, whimsical and sometimes striking print and TV ads that place sleek models against a backdrop of everyday items. The message: Target stands apart from other discounters.

Target spends heavily to keep its stores bright, clean and well organized. The company even calls shoppers “guests” and strives to treat them that way. The store places huge, brightly colored graphics of everyday items in its housewares department, turning toothpaste or paper towels into an icon worthy of pop artist Andy Warhol.

For many, shopping is a mix of price, quality, presentation and emotion. Target understands this and makes it a competitive advantage: The company’s edginess is safe enough for any middle class shopper in a suburban shopping mall.

Target’s bullseye logo is as recognizable as McDonald’s (MCD) golden arches and Nike’s (NKE) swoosh. Target’s savvy customers are in on the clever twist the store has given to marketing “cheap chic” and routinely respond with a faux froggie flip of their own, calling the store “Tar-jay.” That may suggest loyalty and affection for the chain. Whatever it is, it keeps the cash registers ringing.