CAMBRIDGE, Mass.�(CNNMoney.com) -- Next week, video game developer Harmonix will launch the wildly anticipated The Beatles: Rock Band, uniting one of the most popular video game franchises ever made with history's biggest rock band.

The collaboration is the work of a 320-employee company now owned by MTV. But it wasn't so long ago that Harmonix' founders -- Alex Rigopulos and Eran Egozy, two computer-tinkering hobbyists drawn together by a shared love of music -- were disillusioned upstarts running a struggling company. The two recently sat down with CNNMoney in their Cambridge office to talk about their bumpy road to success and how they almost failed -- twice.

You two met as graduate students at MIT's Media Lab. How did you land there?

ERAN EGOZY: I was an electrical engineer/computer science undergrad major at MIT, but I also play classical music -- the clarinet. I've always had those two interests, which throughout high school and college were separate. It wasn't until I discovered the Lab that I was able to combine those things.

ALEX RIGOPULOS: I came to MIT's computer music group from the opposite direction. I was a music composition major and a hobbyist programmer since junior high. I was a pretty lousy composer -- I knew I wouldn't go professional. At that point, I had no idea what I would be doing for a job.

ERAN: For me, you could read the tea leaves if you looked at what I was doing early on. In junior high, I had an Apple IIe -- remember that thing? I wrote a program that could play music on that in machine language.

ALEX: I have never written a line of machine code.

ERAN: I think it was at MIT, working for a professor in this computer music group that combined those two things, that made both of us think 'this is exactly what I want to be doing.'

ALEX: As we were finishing grad school at lab, we were doing work in an area so weird that I figured no one would actually pay me to do it. Getting a job didn't seem like an option. Starting a company was the only avenue at my disposal to continue to do the type of work that I wanted to do.

ERAN: We became interested in the idea of using technology to allow non-musicians to express themselves musically. The big aha! moment came with this computer music system --

ALEX: That could compose music on the fly, algorithmically.

ERAN: It would generate tunes, play music on its own, sort of composing it as it went along. At one point during this, Alex was playing flight simulators --

ALEX: Goofing off

ERAN: -- with a joystick to control the airplane, and he said, 'What if we use this joystick to control the music system?' After spending a couple of days hooking up the two things, we were able to configure it so people could physically express whatever emotion or idea of music they had in their heads by moving the joystick around. It made you feel like you were playing music, even if you didn't know how to play an instrument.

ALEX: We demoed the tech at the Lab, which, at the time, had a lot of corporate sponsors such as Sega and Yamaha. It generated credible enthusiasm -- it seemed magical to people to be able to improvise music that matched what they were hearing in their heads.

Then, after you graduated in 1995, you launched Harmonix.

ERAN: We raised an initial round of capital from friends and family, meager by today's standards -- $100,000 -- but it lasted us a whole year because I was still living like a grad student.

ALEX: And I was living in my parents' house.

ERAN: Somewhat selfishly, we just wanted to keep working on the cool things we were doing at the media lab. Our revenue was pretty much zero for five years.

ALEX: Not quite five -- there was the Disney (DIS, Fortune 500) project, Innovations at Epcot...

ERAN: Edu-tainment! I'm amazed it's still there. We did that project -- our first-paying gig -- for Disney in 1998.

ALEX: Before that, our first product was a PC CD-ROM product, the Axe. It wasn't a game, it was a joystick music improvisation system.

We sold only about 300 copies -- a horrendous failure that led to a painful lesson. The product made an incredible demo -- everyone who stepped up to try it thought it was magical -- but then, after 15 minutes they lost interest. You can't really build a business on an entertainment experience that only keeps people entertained for 15 minutes.

But that lead us into the gig with Disney, which instead of a joystick, used infrared sensors to track your hands. If you moved your hands higher and lower, a musical pitch would rise and fall.

ERAN: The deal put us on the mindset of 'oh, we're a location-based entertainment company, let's go off and find the Disneys, Dave & Busters, museums...' It was an awful business model. It turns out that closing a deal in that industry took 12 to 18 months. We had to find an exit strategy.

And clearly, the way to have Harmonix be successful is through the karaoke industry in Japan -- clear as day!

ALEX: At the time it was! Karaoke was a $10 billion business in Japan. We figured we'd have this consumer-oriented, low-barrier-to-entry, music-making product and bring our act to the karaoke rooms over there.

ERAN: All the Japanese would be playing music because of us.

ALEX: We tried to make that work for a year and a half.

ERAN: But doing business in Japan is expensive...

ALEX: And hard....

ERAN: And for a small company like us, we had no idea what was going on. It was expensive to get over there, expensive to hire a translator, and we weren't reading the signals very well.

ALEX: They're so polite -- the words that come out of a Japanese businessperson's mouth mean something very different than the same words coming from an American businessperson. At this point, we were well into the summer of 1999, showing off our music improvisational system at a karaoke trade show.

ERAN: We were busy. We had hired actors and models, and at one point, I'm looking around going, 'where's Alex? I don't see Alex anywhere.'

ALEX: I was watching people interact with our product, and the realization came crashing down on me -- we had spent 18 months on a music system that was fundamentally flawed. Karaoke isn't about personal expression. It's about people reproducing the songs they know as accurately as they can. The whole notion of adding improvisation elements just wasn't connecting. So I retreated to my hotel room and was depressed for the next two days.

The company was on the rocks. We had zero revenue. We had been trying for four years to make something work. We were out of ideas. Those first four years had been a graveyard of misstarts and product concepts that never made it anywhere.

Worse, there was adequate information about two years into those four years to realize that our big concept was fatally flawed.

ERAN: The problem was that we didn't want to hear that. As an entrepreneur, you have to believe in what you're doing with an against-all-odds mentality -- and, at the same time, listen to what the marketplace is telling you. You have to adjust if you're on the wrong path.

ALEX: There's an entrepreneurial instinct to postpone bad news. One of the big lessons we learned is that the right way to run a successful business is to run toward the bad news as quickly as possible and find the flaws.

So there you were, in Japan, deflated. How did you move on?

ERAN: There was a fairly pivotal moment over there when we saw this form of music game play -- in games like Beatmania and PaRappa and Dance Dance Revolution -- that was really compelling and addictive. We thought that maybe we should be the music company that takes these types of ideas -- more simple music-making ideas -- and bring them to the U.S.

So, after starting as a music tech company, we became more of a gaming firm.

ALEX: But game development is a different set of talent. Back home, we laid off 40% of our employees to start to rebuild. We had no choice -- we were in a cash pinch. We were shifting the company strategy away from multimedia creative software to games, and there's a certain expertise and design sensibility that is very game-specific.

ERAN: So now we begin another series of failures ...

ALEX: Yeah, but at this point we have revenue and were actually paying the bills.

ERAN: The great thing about our first game, Frequency, is that we finally went from cash-neutral to positive. The standard business model for game development is that a publisher like Sony (SNE) or Electronic Arts (ERTS) will fund the development of the game, and they're responsible for marketing, sales, and distribution. A lot of game development studios are just a couple guys in a garage who don't have any money.

We were fortunate to have investors behind us -- during our transition we had closed a round of financing and had secured about $2 million in the bank -- which meant we were in a much stronger position to negotiate. For example, we were able to secure a contract that allowed us to keep a lot of the IP behind our games. That was important because it would allow us to build on past successes.

So tell us about Frequency.

ALEX: In terms of the game itself, Frequency was an electronic rhythm-action game. You had to play the rhythms correctly but also got to choose what track and instrument you played.

But neither Frequency, nor its successor, Amplitude, was very successful, sales-wise.

ALEX: There were some flaws in the games that we didn't appreciate at the time.

For one, the music wasn't mainstream enough. But a deeper problem was that if you hadn't tried out the game, it made no sense. It was completely mysterious. We naively believed that if we, backed by a big publisher, created a game that was fun, it would be successful. What we failed to recognize was that you have to make games that are easily marketable.

We got better with our next set of games, Karaoke Revolution, in which you look at the screen shot and immediately know exactly what the game is all about. Also, the soundtrack was far more mainstream and pop-y.

How did you land the Karaoke Revolution deal?

ALEX: Konami came to us. It was one of three publishers in Japan and it wanted to release a singing game in the U.S. At that time, we were pretty much the only stateside game developer focused on music games.

Karaoke Revolution was a solid base hit. It wasn't as compelling as Frequency or Amplitude, but its marketability and mainstream music made it much more successful.

So was your big hit, Guitar Hero, an evolution of all these games?

ALEX: In a sense, yes, but there was one non-music game that we should mention. It was the EyeToy: AntiGrav, developed for Sony. It turned out to be the worst-reviewed game from a critical review standpoint, yet it sold four times as well as Frequency and Amplitude.

We got really gloomy. We started to wonder if everything we were trying to do was just a fool's errand. When it came to making music games, we couldn't make any money or even a return for our investors. We were paying the bills, but to go on with the business would have been a departure from the founding premise of the company. It would have been an emotionally and psychologically crushing defeat.

However, right around that time we were contacted by RedOctane, a small company that had some experience with peripherals. They said, 'Hey, we love your games. If we make a guitar controller, will you make the guitar game?'

ERAN: And we said, 'You betcha!' Although back then, peripherals and music games were both niche markets.

ALEX: It was like, how is this going to work?

ERAN: We did it because the concept was just so compelling. It was the game we had always wanted to make.

ALEX: And never thought we'd have the opportunity to make!

ERAN: The nice thing about our previous game, Karaoke Revolution, was that you have a mic, you know what to do. Guitar Hero was the same thing, a combination of all the different elements. And it was our first game that started selling like hotcakes. Month after month it was selling more, which doesn't really happen in our industry. When we saw that February sales were bigger than January's, we knew something was going on.

ALEX: Around that time, the winter of 2006 -- as Guitar Hero was snowballing -- Activision (ATVI) acquired RedOctane. Suddenly, there were all these game publishers trickling around Harmonix. We had many suitors, but what was so interesting was that MTV was interested. They totally 'got' us as a music company. Harmonix has always been about music first -- games are a means to an end for us. And as Guitar Hero continued to explode, it was a question of needing a partner with resources.

MTV acquired you before the end of 2006. Did you ever feel that you had sold out?

ALEX: No, we didn't feel that way at all. We felt that our time had finally come to compete in the big leagues.

ERAN: I don't think we would have been able to survive as a company being small and independent. We really needed someone like MTV, with their financial and marketing resources, to back what we were planning to do next.

ALEX: With MTV as a partner, we were able to make things happen in our games that never would have happened. For example, I don't think the Beatles game would exist without MTV's connections.

My boss, Van Toffler [the president of MTV Networks], is a family friend of the Harrisons. The whole thing started a few months after MTV bought Harmonix. Van was vacationing at some Caribbean island over Christmas break and George Harrison's wife and son, Dhani, were there as well. One night over dinner, Van commented on how he hadn't slept well the night before, and Dhani's response was something like, "I didn't sleep well either; I was up all night playing Guitar Hero."

He started raving about our game, and Van told him that MTV had just bought our company. Eventually Van introduced us to Dhani and talks got started about collaborating ... The point is, the fact that the head of the music group at MTV is friends with the Harrisons certainly didn't hurt us.

ERAN: But it still took forever to get that deal done. Although, by Beatles' standards, it was pretty fast.

ALEX: On the day we announced the deal, George's wife, Olivia Harrison, joked that it was the fastest they'd ever done anything.

Was developing this game -- answering to such a different set of collaborators -- more difficult than what you went through with previous games?

ALEX: The Beatles: Rock Band is really our first collaboration with a major recording artist. In terms of the art assets and the story mode and all of the visual aspects, it was us, the two surviving members of the Beatles, Olivia Harrison and Yoko Ono creatively involved in a joint process. We would come up with a design framework and propose it to them; they'd come back to us with feedback on ways they wanted it modified. There was this cycle of iteration that happened all the way through the project.

ERAN: Down to the minute details of how John Lennon looked in the game.

ALEX: Yoko was sitting on the couch pointing out that no, she wanted John's eyes to move that way...

ERAN: We weren't used to working that way, working with material that was so important to someone else as to how it looked to them. It was difficult. But their criticism was always spot-on. For example, Ringo would say, "You know, when I drum, my elbows don't quite go up that high." And a week later we'd come back to him with a modification.

ALEX: We had some great experiences with Paul McCartney over the story mode part of the game. What you'll see is that we added a narrative context around each of the songs you're playing -- there are bits of trivia swirling around about what was going on in their lives and careers.

Initially, we had put together our own set of these facts -- things like how the haircuts originated and other bits that have been accepted as fact in Beatles mythology over the years -- and brought it to Paul to review. We went through it moment by moment, and many times Paul was like, "no, it didn't happen that way," and corrected us. So one of the fun things about releasing this game is that there's going to be all this stuff that Beatles superfans will say "you didn't get it right!," but in fact we'll be setting the record straight on some of the fallacies.

You're also releasing Rock Band Network, which will allow songwriters to upload their own music that can then be played in the game.

ALEX: The model in the past has been us licensing music. Now we want another platform that will help any band in the universe to get onto the Rock Band platform.

ERAN: We're changing the way the music industry is working, and we're hoping there's going to be this big community around it.

ALEX: By blowing it open so that any musician can get on this platform, it changes the way the world perceives what we do, which is now just an expected part of music entertainment. If there's a band you love that releases a new album, you're not only going to want to go see them in concert or listen to them on your iPod, you're going to want to play with that music. Launching Rock Band Network is a way for us to open new fundamental form of music entertainment.

ERAN: One thing we're proud of: If you look back to 1995 and read the mission statement of our first business plan, it's exactly the same as it was today, which is to enable everyone the experience the joy of making music.

That's what we've always wanted to do, and it's been a really tough road to get there. A long and winding road...

ALEX: Argh, the metaphor!

ERAN: Argh!

ALEX: As an entrepreneur you never want to lose site of the mountaintop you're trying to get to, but you have to remain incredibly flexible about the path that you take to get there, which often needs to change direction. Fortunately, we didn't have to abandon the mountaintop.

So you love what you do...

ERAN: Of course. And we don't think we're done.

To write a note to the editor about this article, click here