Five years ago some engineers at Kenner Products, a toy company, came to the creative conference with a joke - a wooden model of a baby doll that chewed its food and then eliminated it into a disposable diaper.

The company's top executives, creative people, engineers and designers are sometimes a loud, lively group at the regular Monday meetings. They present ideas come from outside inventors or from within the company. Then the decision comes: "Kill" or "go ahead." This session was especially lively, with many jokes about peristalic action, until Bernard Loomis, Kenner's president and a man with the fatherly appearance of a large teddy bear, delivered his verdict: "It's very funny, and I think it will sell a million dolls."

Baby Alive, as the doll was called, became one of the industry's all-time best sellers. The supply ran short the first year. Kenner public relations man John Beck remembers the demand.

"I had a grandmother call me from New Orleans. She said her daughters in Dallas and Oklahoma couldn't find Baby Alive in the stores. She said, 'It it available in Atlanta? - because if so, I'll fly down there and get one.'"

Toys are big business: 925 U.S. toy and game manufacturers . . . retail sales of $4 billion last year . . . 235 items in the Kenner catalog alone; conceived, designed and manufactured by the companys 2,500 employees . . . Kenner sales comfortably in excess of $100 million a year . . . a company warehouse that at box has inside more than 800,000 boxed toys worth more than $20 million . . .

The big Kenner factories, located on acres of Cincinnatis industrial suburbs, are as grim and factory-like outside as the toys inside are bright and delightful.

Inside, assembly-line workers are turning out "Star Wars" poster paint kits and a popular new toy called Milky, the Marvelous Milking Cow. You pump its tail, it drinks water from a trough, moos, and gives whitish pretend-milk through a plastic udder. Most of the assembly lines are shut down now, and many workers laid off for the Christmas low season. Most of this year's toys are already in the stores.

To an extent, the American toy business is even recession-proof. "People buy toys when they haven't got money for anything else," says Ted Erickson, a spokesman for the 255-member Toy Manufacturers of America. "What it comes down to is the emotional content of the product. You come to Christmas time and you may be worried about your job, but you'll put off the purchase of a new refrigerator to make sure that the kids get something."

SCENE. It is Pearl Harbor day. David Okada opens the door of his small corner office in Kenner headquarters high in a downtown sky-scraper. He is assaulted by squadrons of paper airplanes.

Screams and shouts. "BLAM BLAM, BLAM. "Rat-a-tat-tat-tat-tat-tat-tat."

Okada is Hawaiian born and of Japanses extraction. He's used to this. In fact, he relishes it, encourages it among his subordinates. As Kenner's design, he is one of the preliminary design, he is one of the company's two top creative persons.

"We combine, twist, massage (ideas) until they're touchable, feelable, affordable toys," he says. "We're the scroungiest group in the company. It's a lot of fun. Yesterday was whoopie-cushion contest day.

"We do things like that to hang loose." Loomis, the president, encourages this too. "I want the people at Kenner to wake up feeling happy," he says. "The biggest obstacle to creativity is fear."

ension, on the other hand is something that Okada encourages. "There's an incredible amount of tension here." he says. ". . . We try to discover, anticipate what will be the big craze you can bring out a toy line on . . . I want our group to be the smartest, most agressive, creatively vicious group in the world. We try to aggressively crcate and develop profitable products. To do this we will spill our guts out, explore all areas of appeal . . ."

Okada talks with machinegun rapidity, waving his hands in the air, rolling his eyes, writhing in his chair. He is trying to convince you that he is slightly mad.

Okada's personal resume seems quite bland - an engineering degree from the University of Hawaii . . . master's in design from Stanford . . . Army time . . . work as a systems engineer at Peal Harbor . . . then seven years with Mattel Co., the country's single largest toymaker.

A friend's suggestion got him into the toy business, but at 36 it is the chance to let out some of his creative energy that keeps him there. Okada has his own creative conferences with his 20 designers, engineers and artists. What they do is top secret.

"We are gross, we are lewd in this group," says Okada of his staff" . . . We do not try to stifle ourselves too much, and this lack of stifling often goes into the sexual, bathroom-type of humor . . ."

This has not yet resulted in a sexually explicit Kenner doll.

The public will accept bodily functions - ingestion and defecation - but they're not ready for sex.

"Toys are a fashion," says Okada, explaining why his shop must work so frantically to keep up with changes, come up with new ideas. "Things change overnight. Evel Knieval - Ideal lost its bottom (on a Knievel toy) this year. These acts of God, some cane affect you: Evel Knievel hit someone with a baseball bat."

Nor are movie-toy rights always sure-fire money makers, Okada says. Example: "Mattel lost its cheeks on 'Chitty Chitty Bang Bang.'"

(Ideal toy spokesman Rose confirmed that there has been a "dramatic decline in sales" of the Evel Knievel toy, "aggravated by the recent adverse publicity." Of "Chitty Chitty Bang, Bang" Mattel spokesman Rubenstein said "The film didn't do that well, and the toy reflected that." Rubenstein added that "historically" the company has steered clear of movie licenses because of the difficulties of predicting how well the movies will do.)

Baby Alive, which has short blonde hair and which makes a continuous grinding sound as it eats a special green gel, has been so popular that Kenner followed it with a Baby Alive Nursery Center ("To feed, change and carry your Baby Alive"), a Care Set ("Have fun 'mothering' your Baby Alive") and a Stroller-Rocker "for those 4 1/2 million Baby Alive 'mothers.'"

This year the company is trying two similar new dolls. Baby Won't Let Go ("Her little hands squeeze tight . . .") and Baby Heartbeat, which comes with a stethoscope so the child can hear the heart beat.

Baby Heartbeat particularly delights Okada because, he says, it represents a stunning conceptual breakthrough in the "live" doll field. There had long been other dolls with batteries in their chests to make them seem alive, Okada says, but when the batteries wore out this caused a real problem. Children perceived this as death.

But Baby Heartbeat has a magnet in its chest that activates batteries inside the stethoscope.

Okada seems transported by the idea as he talks about it. After all, children understand that equipment runs down from time to time. "But the doll," he said slowly, savoring it, "never dies . . ."

Ultimately, Okada believes, toys are simply entertainment, a way for children to feel briefly in control of their lives.

"I don't look on (toys) as a hugely significant learning experience," he says. "We can't cure the world's ills, but if we can give a kid some safe, repetitive pleasure, that's enough."

A humble enough claim, but it hardly describes the excitement little girls feel when they comtemplate Baby Alive.

Robert Furgeson, Kenner's director of marketing research, remembers once asking a little girl what intrigued her about Baby Alive.

"Well, this doll really . . ." said the little girl, faltering, "well . . . it just reminds me of a hot fudge sundae with whipped cream." Rolling in (Play-) Doh

SCENE. Small room somewhere in the Kenner headquarters complex. Bozes of toys line the walls. Public relations man Beck is showing the company's toy line to a reporter.

He takes down a box, pulls out a toy. Then another. And another. The reporter fiddles with the toy. Beck fiddles with a toy. Soon they are totally absorbed, playing with the toys . . .

The company bows to the wishes of its consumers, he says. At first the Bionic Woman was equipped only with "action suits" to wear, but little girls demanded dresses for her so she could go out on dates with Col. Steve Austin, the Six Million Dollar Man. So now there are many dazzling dresses for her to choose from.

Kenner's toy list, like those of other major companies, is largely arranged in thematic groups or "toy lines." The Six Million Dollar Man and Bionic Woman, for example, are the lead items for a whole series of bionic toys - the Bionic Transport and Repair Station, tattoos and stickers, Critical Assignment Legs, Porta-Communicator, Bionic Mission Vehicle and - for the Bionic Woman - 15 dress styles, a Bubblin' Bath 'N Shower, Bionic Beauty Salon, and a Styling Boutique.

There are also many single items - cars, vans, a phonograph, an Easy-Bake Oven that really works, paint sets . . .

Beck, busy playing with the toys, struggling to get them to work n some cases, laughing, says that Kenner makes all its dolls in black-and-white varieties - no racial discrimination.

The company continually elaborates on successful old toys such as Play-Doh, the safe, multicolored clay that children can mold. It has been a top seller for two decades and this year Kenner offers a new Play-Doh item called The Fuzzy Pumper Barber & Beauty Shop.

You fill the heads of little plastic figures with Play-Doh, place them on a barber chair, then pump a lever on the chair on the chair that causes the Play-Doh to be squeezed out through hundreds of little holes in the heads. It looks more like spaghetti than hair, but it can be trimmed, combed and shaped.

Stretch Armstrong has also become a Kenner favorite, and this year the company has added Stretch Monster, suggesting in its catalog that the handsome blond wrestler can do battle with the green, toothy reptile from the deep. Both are made of special latex that allows them to be stretched and contorted to an extraordinary degree but still return to their original shapes.

"When Stretch Armstrong first came out," says Beck, "my next-door neighbor was having a party - all adults - and he said, 'Can we borrow that?' The next day he brought it back and said, 'You know, you almost didn't get that back.'" A 'Toyetic' Idea

SCENE. Loomis' office. A president's office with big desk, big sofa. As throughout the headquarters, there are pictures of children on the walls, although none of them is playing with toys.

Public relations-man Beck sits nearby. He is jittery, not exactly sure why a reporter is visiting.

"Toyetic," says Loomis. His won Favorite Professional word. He coined it himself.

When he spoke with Steven Spielberg about building a toy line around "Close Encounters of the Third Kind," he told the director, "It sounds like a great movie, but it doesn't sound toyetic."

Spielberg caught on right away. "Well, it's not 'Star Wars,'" he said.

This surprised Loomis, who at that point had not seen "Star Wars" even though he had bought toy rights to the movie.

Spielberg, who had seen it, filled him in.

"Our original planning was that it would be another picture," says Loomis. "It would open and close. It would make a good background for a good toy line. Of course, now the picture's opened - and its never going to close."

Loomis, who still talks with the suggestion of a rich Bronx accent, claims to be the only man in Cincinnati who subscribes to the Daily Hollywood Reporter.

It has helped keep him in touch, and in six years at Kenner he has led the General Mills subsidiary in more than doubling gross sales. Loomis switched from selling hardware to toys two decades ago after a friend convinced him there was more money in it.

But the "Star Wars" coup has not been without its difficulties. Amazing as it seems, there will be no "Star Wars" plastic figurines in the stores by this Christmas, because people in Okada's shop and elsewhere in the company told Loomis it was impossible to perfect them and tool up the factory in time - a process that normally takes 12 to 18 months.

Insisting that Okada's people are "artists," Loomis shrugged his shoulders and said, "You can't tell Michael-angelo to hurry up and paint the ceiling."

Kenner has been able, however, to prepare several "Star Wars" paper items for this Christmas. In an effort to recoup, Kenner is offering in stores this Christmas a flat cardboard box with a "Star Wars" scene on the outside and with a certificate promising that the first four figurines - Luke Skywalker, Princess Leia Organa, the robot Artoo Detoo and Chewbacca, the friendly ape - will be sent through the mail within a few months. It retails for $8 to $16.

While there has been a good deal of criticism of this ploy in the media and elsewhere, Loomis insists that the flat package would make an attractive Christmas gift for a child, although, "If this is the only gift to be received by a child at Christmastime, it would be a mistake."

Despite these production problems, Kenner stands to make a bundle from "Star Wars" toys.

Furgeson, the marketing research man, says in-depth studies by his staff and by outside consultants of more than 1,000 American children indicate that the movie has had an amazing impact on their imaginations.

He said the research showed that about a third of all children have seen the movie, almost half of these more than once. "Even those who haven't, one of the key things they want in life right now is to see it," he said.

"Kids can tell you the name of every character in there - Luke and Leia, the human characters. Darth Vader and Artoo Detoo and See Threepio. It goes right down to the Jawas. Kids'll tell you, 'Those are the Jawas,' the little hooded figures. And this is kids 5- and 6-year-old."

Eventually, Kenner plans to produce a dozen or more of the little figurines based on characters from the movie plus vehicles for them to ride in and other assessories.

Furgeson said that children are surprisingly perceptive in analyzing the characters. "Girls are likely to say they like Luke because, 'He's a real hero.' He's next to God and motherhood, because he did all these things out of love and brotherhood.

"Leia . . . they say she's 'just beautiful' - but she's also emancipated . She gives orders. She's part of the whole thing . . . She wasn't pushed around in any way. 'She did just as good as Luke and Han did.' She carried a blaster. . . ."

Furgeson has had years of experience in testing the reaction of parents and children to toys or ideas for toys. Most of this work is so secret he won't talk about it. Parents engaged in the testing programs, which take place in communities all over the United States, must sign secrecy oaths about the toys they are asked to give an opinion on.

Despite his experience, however, Furgeson still finds the extraordinary appeal of "Star Wars" somewhat of a mystery.

"Why is 'Star Wars' so unique and different? We don't have all the answers. Our research indicates it's the broad aspects of 'Star Wars,' which comes back to why the 'Wizard of Oz' is a legend - It's all the good things, good over evil, a lot of fun, an escape from reality . . ." Of Rats and Children

SCENE. A series of large rooms. In one, women wearing white smokes listen to Baby Heartbeat's heartbeat through toy stethoscopes, marking down the number of thumps they hear.

In another room, Stretch Monsters are being stretched thousands of times on mechanical racks (the beasts don't scream). In another, a lab technician passes materials through a large machine, an atomic absorption spectrophotometer . . .

Karl Wojahn, who presides over these testing rooms as Kenner's vice president of product integrity, is a very precise man. His desk is almost bare. You can get exhausted just listening to Wojahn go on and on about the measures his people take to insure the safety and reliability of kenner toys.

He'll tell you, for example, that everything Kenner makes is fed to white laboratory rats. Huge quantities are fed to the rats; and if just one dies, he says, the product will be pulled off the market. Wojahn says this is a higher standard than the federal government requires.

According to Erickson, the toy industry spokesman, the toy safety issue is somewhat passe now. Toymakers are more concerned whith the pssible FTC crackdown on their advertising.

Nevertheless, Loomis continues to insist on safety and quality standards at Kenner to keep the consumerists and government agencies off his back. Wojahn is his enforcer.

Social concerns have caused Loomis to shy away from war toys, and this year Kenner offers only one - the Aerial Aces Target Game ("See every hit, hear every score . . ."). Wars toys are enormously profitable and, Loomis is convinced philosophically justified. "The history of civilization deals with heroics," he says. "A rebirth of war toys is possible."

Several of these electrically-run target games, their mechanical guts exposed, are being tested in Wohahn's labs. When the child aims his machine gun accurately at a passing airplane on the screen, two moving wires inside the machine touch, thus scoring the hit.

There are lab workers baking brownics in Easy-Bake ovens, putting Play-Doh in warmers to speed deterioration and painting with spill-proof paint sets to see if there is as much paint inside them as is advertised.

"Our first question is: "Is it safe?" says Wojahn. "Until we sign off, a toy can't start production." A Wholesome House

SCENE.Howard Bollinger puts his head down next to the Family Treehouse and smiles. It is clear that the little smiling man in the treehouse, with his bushy brown hair and mustache, looks exactly like Bollinger.

Bollinger really loves his work. He seems like an extra-zesty Captain Kangaroo. He is vice president of toy engineering and ranks with Okada as one of the company's top creative people.

Three years ago, Bollinger invented the Treehouse. It immediately became a best seller and led to the creation of a whole line of similar preschool "platform toys" - including a Lighthouse and an Amusement Park.

While fantasy seems to be the key to success in toymaking, translating this to specifics is often difficult. Sometimes the company will push toys all the way through the early production stages only to find they don't sell.

Hugh Keiser, vice president for advertising and marketing services, recalls that company officers became very excited several years ago when they obtained a license to make Boy Scout dolls.

"We spent a lot of money and energy developing a line of Boy Scout and Cub Scout dolls with different adventure sets," Keiser says. "These products did not sell. These are types of things a child can do himself."

The same thing happened with a soccer game and a series of sports dolls.In other words, Keiser concluded, successful toys should creat fantasy worlds. But no one can be sure, even of that.

Bollinger's Treehouse comes with a little family set of figurines, including a dog, Barky. "Push the button," says the catalog, "and the leaves of the magical tree pop open, revealing the beautifully detailed, 15-inch high Family Treehouse . . . with a 'click-click' elevator that cranks up and down, an opening front door, foldout stairs and rooms full of Treetot furniture. There is even a swing, a Treetot car and Barky has his own separate dogwood tree . . ."

The idea came to Bollinger one day as he watched his children playing in the backyard with a large piece of plywood, camping on it, covering it with blankets, setting up a little house.

"It's what turns kids on - these little enclosures, these little secret places like the elevator here," says Bollinger, playing with the toy. "See, you crank the little (figurine) up and down, but you can still see her through the window in the elevator door. It's so safe, even when you close it up at night, everybody is secure and safe . . . It's that family feeling of everybody together in a nice, peaceful fantasy . . ."

A wholesome vision for unwholesome times.

"I try to promote healthy fantasies," says Bollinger. "We as human beings must continually strive to improve our philosophical outlooks as to what's (important) in this world, or enlightening, instead of what's degrading. I could have remembered that I would enjoy being in a fantasy treehouse . . ."