By Pallavi Gogoi

Kelly Wei, an 11-year-old, is browsing through new electronic-game releases in the popular R Zone section of the huge Toys 'R' Us (TOY ) flagship store in Times Square. Wei has never played with Barbie dolls and doesn't plan to. She prefers video and electronic games. "In the Smash Brothers game you can challenge people to fight and do exciting moves," says Wei, hugging a Pokemon game she hopes to get for the holidays.

With kids like Wei, Barbie just isn't as hot as she used to be. Nor are GI Joe and Hot Wheels. These traditional playthings are getting serious competition from the likes of Microsoft (MSFT ) and Sony (SNE ) and even Internet sites that offer games.

GROWN-UP ENTERTAINMENT.  Statistics show that big brand-name toys don't sizzle like they used to. Barbie sales dropped 26% in the U.S. and sagged by 13% worldwide in the third quarter. Hasbro's (HAS ) core brands, which include GI Joe, declined 4.5% in the first three quarters of the year. Overall sales of toys, video games not included, are down 3% year-to-date, according to NPD Funworld, a consumer-products research firm.

Children are increasingly turning to more grown-up kinds of entertainment. Electronic games and lifestyle products are what they want. "You're dealing with 21st-century children who are hot-wired into an electronic system," says Robert Passikoff, president of Brand Keys, a New York City brand consultancy.

At the same time, technology has opened the door to a vast selection of games. Microsoft sold 2.4 million copies of its Xbox game Halo 2 on the first day of its release, Nov. 9. Electronic Arts (ERTS ) sold 2 million units of Madden NFL Football in its first five days on the market. Some analysts expect the video-game software business to grow by 10% in 2004, up from last year's $4.9 billion in sales.

SOPHISTICATED KIDS.  It's not just video games that are taking the place of big-brand toys. "Kids are even forgoing toys and saving up for CDs or an iPod," says NPD's Michael Redmond. And preteen girls and boys, termed "tweens" by marketers, are using more of their money to buy not-so-childish products like makeup, jewelry, and body spray. To meet this demand, companies like Unilever (UL ) and Procter & Gamble (PG ) have launched brands like Axe and Red Zone. Claire's Stores (CLE ), a jewelry and accessories chain for young girls, has been a huge success.

Mattel (MAT ) and Hasbro are hardly ready ready to give up on their core brands. Bob Eckert, Mattel's CEO, plans to overhaul the Barbie brand, infusing her with an edgier lifestyle, and has launched a clothing line and an ad campaign promoting the made-over doll. "Our latest subline, Fashion Fever, is designed to rebuild Barbie's fashion-forward image with girls," says Eckert in a conference call with analysts after releasing dismal third-quarter earnings Oct. 13. At the same time, Hasbro chief Alfred Verrecchia plans to "work on" GI Joe to power up his image.

Yet some experts bet these efforts to save classic toy brands may be in vain. The latest research shows that the surge in technology use has resulted in a spike in children's knowledge development. So, at a younger age, kids have the intellectual capacity and digital dexterity to not only surf the Internet but also play games that are more complex.

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