This is a common feature in computer and video games, but the price of the technology has only recently dropped enough to put it in a stand-alone toy. Video games have a lot to teach the toy industry -- last year video-game sales shot up 20% while toy sales stayed flat. Toy companies have learned that parents are willing to shell out for a video-game console because kids play with them as they grow older, tackling harder levels and new games. Yet experts agree that there will always be a place for the real thing. "Computers and video games add challenges and depth, but they don't appeal to your senses like a real toy," says Judy Ellis, chairwoman of the toy-design program at the Fashion Institute of Technology. The best of tomorrow's toys will do both.

When Zowie Intertainment began testing smart toys three years ago, it found that children wanted the object to be as much like a conventional toy and as little like a computer as possible. "The kids didn't want to move a pen on a tablet and see some kind of scenario onscreen. They wanted to make a real 3-D character walk the plank on a real toy ship and see him fall into a lifelike ocean," says Amy Francetic of Zowie, a Silicon Valley start-up funded by Microsoft co-founder and technology visionary Paul Allen. The folks at Zowie ended up creating a toy pirate ship. When it's plugged into a computer, digital tags in the figurines and sensors on the ship translate what the child does into action on the computer screen. Kids play with the figurines and then see their characters move onscreen in video-game-like environments.