I know kids shouldn't watch too much tv, but I bought my son a few dvds called "Preschool Prep Sight Words." It shows a word, says the word over and over, and then turns the word into a cute little cartoon. It's simple and my son loves it! He turns three in a couple of weeks and he's learned all the words from the dvds (about 40) and is starting to point out simple words on signs and in books.
Of course, we also play games. I'll write a word and ask him what it is. Or I'll open Microsoft Word and let my son push the keys and watch the letters appear on the screen (I use a really large font, so it's easy to see). He really loves this game. When he's finished pushing the keys (he calls it "making words"), I type a simple word and see if he can read it. If he gets it right, we laugh and clap.
Also, I'm starting to ask him to read very simple parts of books. His favorite is "Duck and Goose Find a Pumpkin." On every page, it asks a question ("Is the pumpkin in the pile of leaves?") and then the next page just has the word "no." I read the question, and then point to the word "no" and have my son say that part. We do this with some other books, too.