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Taking off immediately from the end of The Faceless Ones in 1966 London, the Second Doctor and Jamie watch helplessly as the TARDIS is loaded onto a lorry and driven away from Gatwick Airport. The trail leads them to an antique shop run by Edward Waterfield, who sells Victorian-style antiques that curiously seem as though they were still new. Investigating the store, the Doctor and Jamie succumb to a booby trap that gasses them. They wake up to find that they have been transported to 1866, and are in the house of Theodore Maxtible, Waterfield's partner. The two had been trying to invent a time machine using mirrors and static electricity, when the Daleks emerged from their time cabinet. The Daleks then took Waterfield's daughter Victoria hostage and forced Waterfield to travel a century forward in time to lure the Doctor into a trap by stealing the TARDIS. Waterfield is obviously fearful for his daughter's safety and his own, but Maxtible seems to be going along with the Daleks for his own reasons.
The Daleks threaten to destroy the TARDIS unless the Doctor helps them by conducting an experiment to isolate the "human factor", the unique qualities of human beings that have allowed them to consistently resist and defeat the Daleks. Once the Doctor has isolated the human factor, he will then implant it into three Daleks, which will then become the precursors of a race of "super" Daleks, with the best qualities of humans and Daleks. To that end, the Daleks want to Doctor to test Jamie by sending him to rescue Victoria, who is being kept in the house. The Doctor is strangely co-operative with the Daleks, manipulating Jamie into the rescue mission but not telling him of the nature of the test. Jamie manages to rescue Victoria, but she is taken prisoner again and transported through the time cabinet. The Doctor, observing how Jamie accomplished the rescue, distills the human factor, but continues to harbor suspicions that there is more to the experiment than just this. Once the human factor is implanted in the three Daleks, they become completely human in personality and seem almost child-like, although the Doctor says their mentalities will mature quickly. This was the Doctor's intent all along, that the human factor would lead to "human" Daleks that would be friendly to humanity. He christens the three Alpha, Beta and Omega, but they soon return through the time cabinet to Skaro, the Dalek's home planet.
Meanwhile, Waterfield has discovered that Maxtible has betrayed them all to the Daleks, hoping that he will be able to learn the alchemical secret of transmuting base metals into gold. However, Maxtible is discovering just how ruthless the Daleks are and how empty their promises can be. Jamie, Waterfield and the Doctor manage to escape through the time cabinet to Skaro before a Dalek bomb destroys Maxtible's house. Maxtible has done the same earlier, and is tortured by the Daleks for his failure to bring the Doctor to them. At the same time, the trio have found their way into the Dalek city and are brought before the imposing Dalek Emperor, who reveals the true reason behind the experiments and the capture of the TARDIS. By isolating the human factor, the Doctor has succeeded in isolating the dalek factor as well. The Daleks will use this "dalek factor" - the qualities that make the Daleks mindless killing machines - to reconvert the "human" Daleks. In addition, the Emperor wants to Doctor to use the TARDIS to spread the dalek factor throughout human history, turning all humanity into Daleks. The Doctor knows that the Emperor realizes that he would die before complying with this order, and so is concerned about why the Emperor seems so confident.
Maxtible is put through an archway that infuses him with the Dalek factor, turning him into an obedient Dalek drone. He hypnotizes the Doctor and puts him through the arch as well, apparently converting him. However, the Doctor is feigning his conversion, and secretly plants a device on the arch while the Daleks hunt for the three "human" Daleks. As one still remains to be found, the Doctor suggests that all the Daleks be put through the conversion arch so that the "human" Dalek will once again be infused with the dalek factor. As the first batch of Daleks go through the arch, the Doctor frees the others. The arch did not work on the Doctor because it was calibrated for humans, and he is not one. The Doctor has also switched the dalek factor for the human one on the arch so the Daleks that go through will become human as well, and rebel against the Emperor. The Emperor calls out his black Daleks as the rebellion spreads and the city falls into chaos. Waterfield throws himself in front of a black Dalek blast meant for the Doctor. The Doctor promises that Victoria will be taken care of, and Waterfield dies content. The Emperor is attacked and exterminated by the "human" Daleks, as is Maxtible, who dies screaming of the everlasting glory of the Dalek race.
The Doctor tells Jamie that they will be taking Victoria along on their travels. Jamie, Victoria and the Doctor watch the Dalek city in flames from the top of a hill as the civil war continues. The Doctor pronounces this as the end of the Daleks - the final end.