(FORTUNE Magazine) – It beggars belief that a revolutionary gadget launched from the valley of digital hype--a technology that promises to transform TV at least as much as cable and satellites have--could somehow slip in beneath our radar. Maybe it's because we Silicon Valley journalists are so fixated on Internet startups, IPOs, and e-everything that we forget lowly consumer-electronics devices can be cool too. Or maybe it's lousy marketing on the part of TiVo and Replay Networks, the rival startups promoting this technology. They've been so busy trashing each other's nearly identical products that they haven't even settled on a name for what customers quickly agree are amazing gizmos.

I'm talking about a genre of TV set-top box that has been called the PVR (personal video recorder), the PTV (personal TV), the TVHD (TV hard disk), and more whimsically, the Time Machine. (Check out FORTUNE's contribution to the name-that-puppy debate in Joel Dreyfuss' review of the TiVo and Replay machines in this section. He dubs them DVRs, or digital video recorders.)

These boxes, which look nondescript and retail for $500 and up, are a cross between a PC and a VCR, without the complexity of either. A DVR incorporates a hard-disk drive, a modem, and silicon circuitry. It converts TV programs entering your home via cable, satellite dish, or antenna into digital bits (up to 30 hours' worth) that the hard drive can store for you to view at your convenience. Thanks to the modem and computer smarts, the DVR provides up-to-date, annotated, interactive onscreen listings of what's on TV this week. With a single click of the remote, you pick what you want to see now or record for playback later. The DVR even sets its own digital clock.

Sounds like a fancy digital VCR, doesn't it? The DVR is far more than that--though it lacks the VCR's ability to play pre-recorded tapes. It's a Trojan horse that could surprise couch potatoes, gadget makers, media moguls, and advertisers with radical change. For viewers, it offers convenient control over when you watch your favorite shows. What's more, because the DVR records whatever you have on, it makes watching live TV more like viewing a tape: When the phone rings, say, you can pause the ball game to take the call, then pick up where you left off.

For consumer-electronics makers, the DVR not only breathes new life into the television set but also promises to spawn multibillion-dollar markets for products that combine the smarts of computers, the interactivity of the Internet, and the easy familiarity of TV. The effect on broadcasters will be greater still. If DVRs catch on--Forrester Research of Cambridge, Mass., predicts that 13% of U.S. households will have one by 2004, an adoption rate faster than that of VCRs--they will force TV stations and networks to rethink how they schedule and distribute programs. That's because, yes, DVRs let you skip commercials with ease. Advertisers will feel added pressure to come up with ads "sticky" enough to keep viewers from zapping them.

The boxes raise fascinating questions, says computer-industry columnist Stewart Alsop, my FORTUNE colleague whose day job is as a venture capitalist. His firm, New Enterprise Associates, in Menlo Park, Calif., is a primary backer of TiVo. "What is the function of a broadcaster if it no longer controls when people watch what it airs?" he wonders. "What is the relationship between broadcasters and advertisers if viewers have the option of skipping the ads?"

Small wonder that Replay Networks founder Anthony Wood spends much of his time negotiating with business-development guys from companies like CBS, Disney, Matsushita, and Sony, which fear being caught flat-footed by the DVR. It's why he hired former Hollywood TV production exec Layne Britton as his right-hand man. It's why General Electric's NBC was so curious about DVRs that it leaped at the chance to become a TiVo investor.

The idea of storing video on hard drives is nothing new. It is attractive for the same reason it's nice to have music on CDs rather than tapes--the quality is high, and you can jump from track to track without having to rewind or fast-forward. Years ago a Silicon Valley startup called Frox tried to build a smart TV that could pull off the feat, but it was stymied by costly and inadequate chips and hard disks. Now digital video compression and huge, cheap hard disks make it practical to store video as if it were a massive computer file.

Wood ran up against technology limitations when he tried to start Replay six years ago. Instead he fired up an Internet software startup and sold it to Macromedia in San Francisco in 1995. In 1997 he bolted and started Replay with the proceeds from the sale. "It was strictly a hardware concept," he says, "but by early 1998 we realized that the network service that goes with a DVR is what could provide the real revenue stream." This is, finally, what differentiates a DVR from a VCR: The former is a service, the latter, just a box. A DVR has a two-way connection, so TiVo and Replay can provide you with customized listings, personalized services like home shopping, and easier pay-per-view programming. The two-way connection also lets advertisers learn about your habits and direct targeted advertising your way.

To get a sense of how ambitious all this may be, consider some applications that the geeks at Replay and TiVo are coming up with. In the next year, some cable and satellite channels will begin broadcasting electronically scrambled movies during "dead time" after midnight. DVRs will record these for unscrambling and viewing later. If the customer who orders a movie actually watches it, the box notifies the Replay or TiVo network server, which bills him and pays the broadcaster. If the customer never gets around to watching, he isn't charged. DVRs also make it possible for users to order custom channels that collect, say, every episode of Friends or that scan news programs for segments about particular sports teams or companies. The downloaded channels could be sponsored by advertisers, whose logos might float in a corner of the screen or who might send along interactive ads.

TiVo and Replay also envision that DVRs will merge with other devices. Sony has plans to make TVs with DVRs built in. Panasonic will soon produce Replay machines with built-in DVD players. Cable operators are thinking about replacing set-top boxes with DVRs.

The DVR is likely to outgrow its Silicon Valley roots to become the first consumer-electronics hit of the millennium. Unlike Microsoft's WebTV, TiVo and Replay realize that while many people use computers, most prefer to watch TV. Says TiVo co-founder Jim Barton: "Sure, there's hard-core technology in these boxes, but this isn't the computer industry riding in to save TV. We just want to make it easier for people to find something decent to watch."