What's a gruffalo? Why, didn't you know?

At a recent children's party in Islington - that London borough being the home of the bien-pensant parent - there was no dodgy magician, tragic clown, or even musical chairs. These would have been far too cheesy and competitive. No, this modish mum and dad instead created a puppet performance of The Gruffalo. Of the 20 or so children present, all of them knew every word and chanted them in unison, a sound as angelic to their parents as it must have been demonic to the neighbours.

It may be that you haven't come across The Gruffalo yet. If so, then you almost certainly don't have a child under the age of eight years old. Written by Julia Donaldson and illustrated by Axel Scheffler, this cultish book was first published in 1999. Shortly afterwards it was dubbed "a modern classic", scooped the Smarties Gold prize (the equivalent of the Booker prize for children's literature), took the Blue Peter award for the best book to read aloud and the Experian Big Three prize. It became - and remains - one of the UK's best-selling picture books.

Five years on, it is soaring with unstoppable momentum. A play has been made of it and, lately, a film of the play, from Andrew Lloyd Webber's Really Useful Company - it currently sells direct from Really Useful's website, and will be distributed this Christmas. Several television companies and a Hollywood film production house have recently tried to grab some Gruffalo action. There is merchandise such as jigsaw puzzles and toys, even though the publisher hasn't truly put its mind to this cash cow yet. Last year, the book passed its millionth sale and it is fair to say that The Gruffalo has entered the canon of best-loved children's books that includes AA Milne's Winnie The Pooh, Dr Seuss' The Cat in the Hat and Maurice Sendak's Where the Wild Things Are - a book with which it has something in common.

The Gruffalo has a kind of folkloric depth: pick it up, and it's as if you've read it before. "A mouse took a stroll through the deep dark wood," it begins, and, as the heroic rodent walks he saves himself from being devoured by a fox, an owl and a snake by spinning them a story about a menacing monster with which he is about to have lunch: "He has terrible tusks, and terrible claws, and terrible teeth in his terrible jaws." The mouse's would-be predators leave him unharmed, but then he meets a real and hungry gruffalo - the imagination made flesh - ready to eat him. The quick-witted mouse boasts to the dim and aggressive beast that he is the "scariest creature in this wood", and takes the Gruffalo back to meet the predators, who run in the face of the monster. The Gruffalo believes the mouse is scaring them, and flees. And, like a Zen master who has used his antagonists' aggression against them, the mouse sits and eats a nut. Scheffler's pictures are masterly, and it all rhymes, a rhythmic, read-aloud kid's romp that gathers pace like a rocket.

Michael Rosen, the children's author and broadcaster, loves it. "It's the metrical perfection of Dr Seuss combined with a wonderful story," he says. "It fits together like a crystal, with all the facets in harmony."

Kate Wilson, the director of children's books at Macmillan, publishers of The Gruffalo, says: "It works really well as a shared experience: adults like it as much as children. The Gruffalo is scary without being terrifying, and has great detail. I love that poisonous wart on the end of its nose." The children's book expert Nicholas Tucker, a lecturer at Sussex University, says characters like the Gruffalo have a special resonance with children. "Writing about animals is always popular, and to come up with a new monster with a great name is really skilled, particularly as the monster is scary but also has a cuddly nature."

The Gruffalo has been translated into 26 languages. "As soon as we read The Gruffalo, we saw dramatic potential in it," says Toby Mitchell, of the Tall Stories theatre company, which has its own production. "It's very simple and very concise. We're faithful to the book, and also appeal directly to the audience, who all know it off by heart." The play is now travelling to the US and Canada.

At her home in Glasgow, The Gruffalo's author, Julia Donaldson, is delighted and even a little bemused by the success of her warty beast. "Sometimes I feel the Gruffalo owns me," she says. "It'd be lovely if people mentioned my other books." Donaldson has also written The Snail and the Whale, Room on the Broom, Monkey Puzzle and more, several also illustrated by Scheffler. But The Gruffalo is her magnum opus; her Sgt Pepper, her Ulysses.

Donaldson, 55, is a writer and parent from Scotland who lived in the wilderness for ages, writing songs for children's television. She was a songwriter for Playaway, and, although she had books published, she had periods in the doldrums: "I know what it's like to sit there, unpublished."

In other words, she is equipped to cope with Gruffalo-mania. When three different television companies got in touch, each interested in filming the story, Donaldson was circumspect. "I was particularly worried about one, as they wanted to make it into 13 episodes, which would inevitably change the character of the Gruffalo," says Donaldson. "I didn't want it to become a long-running Tom and Jerry-type cartoon, nor did I want the Gruffalo and the mouse to become friends, learning to count together or something like that. It's a poem, like The Owl and the Pussycat." She seems cautiously to approve of a recent idea to make a half-hour television show, like the perennial adaptation of Raymond Briggs's The Snowman, but when a Hollywood studio got in touch - the idea being to make a blockbusting kids' feature film - it put such emphasis on getting the rights that Donaldson and her publisher backed off. "I'd hate it to become like Winnie The Pooh, with other illustrations of the Gruffalo taking away the essence," she says. "But I'm not saying a film won't happen. We'll see."

It's like that with books that take off, reckons Michael Rosen. "It's a strange process," he says. "It starts by someone reading your book in a way you don't like, then slowly, but surely, it moves it out of your hands. Roald Dahl had that problem with Charlie and the Chocolate Factory and, eventually, disassociated himself with the film. I guess if Dr Seuss was alive, he wouldn't be too happy with the current film of The Cat in the Hat."

The genesis for The Gruffalo came in the mid 1990s. "It's loosely based on an ancient story," says Donaldson. "I was asked to write little plays based around traditional tales. I did lots of research into world folk stories, and came across one about a little girl who went out into the jungle and was confronted by a tiger, which she then outsmarted. I thought it would make a nice little play; then I realised it was the germ of a good picture book." Donaldson chewed the idea over for a couple of years. "It was a time in my career when I'd had only educational books and one trade book published. She'd had rejections and had "very little confidence" at that stage. She started to write, but couldn't get anything to rhyme with "tiger". So she invented a monster with a "grrr" sound, wrote down a list of nasty attributes - wart, claws, orange eyes, knobbly knees, got it to rhyme and worked on the structure. "I hated books with obvious repetition, but decided to use this strong repetition framework with variation within the structure." She added humour, with food references: the mouse tells the monster that its favourite food is "gruffalo crumble".

A publisher sat on the manuscript for ages, then Macmillan was alerted to it by Axel Scheffler. "Within a week I had a letter," says Donaldson, and the company was so keen that it took The Gruffalo to Bologna children's book fair. "They told me they'd never seen so much interest."

Part of The Gruffalo's appeal is that it is a proper fairy tale, and doesn't rely on the reflexive "pro-social" correctness that can afflict children's literature. "It avoids the finger-wagging stuff to which some succumb, myself included," says Michael Rosen. "There is a wider moral, in that the small person can outwit the big person. But while it has a moral, it isn't moralising."

Donaldson has often been asked to write more Gruffalo books, and it seems the cajoling has worked, for this September Macmillan will publish The Gruffalo's Child, the debut for the Gruffalo's offspring. The book is not available yet, but the fact that the monster has mated suggests a whole family of gruffalos live in that deep, dark wood, and perhaps more will emerge in time. As for Donaldson, she will be eternally associated with the Gruffalo. Quite literally, she has created a monster.

'The Gruffalo' by Julia Donaldson, illustrated by Axel Scheffler (Macmillan, £5.99)