James McDermott is one of Levi Strauss & Co.'s top managers, but he works a few miles from the waterfalls, wildflowers, and lush lawns that adorn the headquarters of one of the world's largest apparel makers. His office is in a dingy building in a rundown part of San Francisco.

This year, a handful of managers moved with some fanfare and little else from Levi's lavish digs to the former warehouse. Levi hoped this would stimulate its managers' sensitivity to the fast-growth fashion markets, in which entrepreneurs prevail. But Levi found that successfully competing against small companies means more than superficially imitating their humble surroundings. Cramped quarters didn't help its jeans managers understand fashion any better.

For years, Levi prospered with one strategy: chase the demand for blue jeans. Then came the designer-jeans craze -- and Levi became unstitched. The company diversified into fashion, but initially treated each niche like a miniature jeans market. It slapped its famous name on everything from running suits to women's polyester pants. The results were disastrous: Profits collapsed by 79% last year, and the company slashed about 5,000 jobs.

The company soon realized that it needed to view the fashion business differently. "We need to be like commandos, special forces, and SWAT teams, and that's different from being the Third Army sweeping across Europe," says Leo Isotalo, who oversees all of Levi's business units.

The company partly blamed its plush campus for lulling managers and designers into complacency. So its new approach to fashion called for shuttling some top managers to the decrepit building, where the group devised marketing, merchandising, and distribution strategies for its fashion lines. Traces of the parent were erased from clothes tags and shipping cartons. "They didn't have to worry about thinking or looking like the division next door," explains Thomas Kasten, an executive vice-president.

But Levi's strategy had faulty seams. The idea that an atmosphere of small cubicles and bare fluorescent light bulbs would stimulate creativity was just that -- atmospherics. "They put the people in a dump and just scared them," says one observer. "You can't scare people into creativity."

The company also failed to bring in fresh talent. Employees who understood the jeans market still had no feel for the fast-paced fashion world. And they were far from Manhattan, the nation's fashion capital. As a result, the unit's two lines have been troubled, one so badly that it was pulled off the market for a season.

The lessons haven't been lost on Levi. It recently reached outside to hire fashion designers. And its new unit is based in New York, with few employees drawn from Levi's ranks.