I always believed that the dolls you can buy are all dead (presumably killed by the ruthless doll farmers and poachers). The ones in the wild are soft and cuddly, but when they die, their skins harden into something similar to wood. When discovered by humans, make-up is applied to make them more aesthetically pleasing.

As for reproduction, my belief is that the inner most doll is a newly formed one. It grows up somewhat hollow, and eventually grows a new doll inside itself (a little like a tree forms a bud, which turns into a flower or fruit or whatever). As the (now) innermost doll baby grows, it stretches all the other dolls outside it and they get bigger and bigger. However, the outer-most doll is the oldest, and it cannot withstand the stretching forever, and eventually splits around the middle (which kills it) and it falls off, leaving the next largest to be the outermost doll. Somewhat sadly for the dolls, they only see daylight when they're 'next in line' to die.

Edit: As for propagation of the species and avoiding dying out... How about twins? Every once in a while, two buds form in the centre, and gradually form dolls around them both. As the outer layers age, eventually the 'single' layers break off, revealing two (now separate) dolls.