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It wasn't until Tim Riley was standing in a London recording studio watching the seminal 1970s punk band the Sex Pistols rerecord their smash hit Anarchy in the U.K. that he realized just how popular Guitar Hero had become.

To include the band's songs on Guitar Hero III, Mr. Riley – the man in charge of bringing music to Activision Blizzard Inc.'s video games – needed master tapes. But the original recording of Anarchy in the U.K. had been lost for decades.

Much to his surprise, the surviving members of the band offered to go back into the studio – something they hadn't done in 30 years – just to record a song for a video game where players rock out on plastic guitars in time with coloured dots on a screen.

“It was the craziest thing ever,” he said. “I never thought something like that could happen.”

Tuesday marks the beginning of the latest chapter in the unlikely story of Guitar Hero, with the release of its latest incarnation, Guitar Hero: World Tour.

But what began as a quirky novelty game has evolved into a revenue engine for both the video game and music recording industries. As CD sales continue to decline, rhythm-based video games are starting to fill the void, offering musicians new fans, while providing labels an opportunity to generate new revenue streams from back catalogues.

Like its chief competitor, Rock Band – developed by MTV Networks, a division of Viacom Inc. – the new Guitar Hero will include plastic drums and a working microphone to allow up to four players to rock out as a unit. Both games will be available for all three major consoles: Sony Corp.'s PlayStation 3, Microsoft Corp.'s Xbox 360 and Nintendo Co. Ltd.'s Wii.

In North America, more than 21 million copies of the various instalments of Guitar Hero have been sold, according to NPD Group, while consumers have snatched up 4.5 million copies of the first Rock Band.

Together, the two franchises have generated more than $2-billion (U.S.) in sales, said Michael Pachter, a financial analyst who tracks the video game industry for Wedbush Morgan Securities in Los Angeles.

Where MTV and Activision see the money coming from in the future, however, is from downloadable songs. Although Mr. Pachter estimates the two companies have secured little more than $50-million from the sale of extra tracks to date, they both see great potential in downloadable content.

MTV is offering 20 free song downloads with Rock Band 2, an initiative Mr. Pachter estimates cost the company about $1-million, but gets users comfortable with downloading new songs over Xbox Live or the PlayStation3 Network.

“Those are training wheels to get people in the habit of downloading content,” he said. “You could be selling the same audience $60 a year of content without ever putting a disc out. … That's pretty smart.”

There are nearly 500 songs available on the Rock Band platform from more than 100 artists. There have been more than 25 million paid downloads since the game went on sale in November, 2007. Microsoft estimates that users download nearly four million new songs for Guitar Hero and Rock Band every month over Xbox Live.

When Paul DeGooyer first started trying to convince bands to sign on with Rock Band, some were hesitant. But when it came time to produce the sequel, artists were calling him suggesting songs to be included.

One of the most prominent artists to grasp this was Guns N' Roses front man Axl Rose, who suggested that Mr. DeGooyer – senior vice-president of electronic games and music for MTV Networks – include the just recorded track Shackler's Revenge on the game. It would mark the first official release of a Guns N' Roses song in nearly 10 years.

Even artists who have never agreed to license their songs to digital media such as Apple Inc.'s iTunes have jumped on the rock game bandwagon. Most prominently, Australian rockers AC/DC, who have signed a deal to create a Rock Band-exclusive game featuring 100 minutes of the band's music.

“Bands like AC/DC have made it crystal clear that they are not interested in the digital space because they don't like people cherry-picking their songs, so a physical release was very attractive to them,” Mr. DeGooyer said.

When Activision's Mr. Riley first started approaching labels, he typically dealt with a company's film and TV licensing division. These days, most labels have a dedicated staff working on video game licensing.

However, some labels are worried artists and record companies are being shortchanged. Warner Music Group chief executive officer Edgar Bronfman said last month he would consider pulling his company's artists from these games if a new structure wasn't worked out that reflected the contribution artists, songwriters and record labels make to them.

“The amount being paid to the music industry – even though their games are entirely dependent on the content we own and control – is far too small,” he said.

A short time later, Activision CEO Bobby Kotick told The Wall Street Journal that perhaps it should be the labels paying to be included in the games. “When you look at the impact it can have on an Aerosmith, Van Halen or Metallica, it's really significant … so much so that you sort of question whether or not, in the case of those kinds of products, you should be paying any money at all and whether it should be the reverse.”

Mr. Kotick has also said that Activision, which is owned by France's Vivendi SA, is considering creating a Guitar Hero-branded music download service to compete with Apple's iTunes.