Teaching children to read: whole word vs phonics.....help!?

I'm having trouble understanding phonics. I understand how whole word methods work, and that they can cause advancement very young (see this: http://www.youtube.com/watch?v=k1OdBcNAfIw). But I've also read that children can become confused by whole word when they're older as they are just memorising the shape of the word. My question is, how does a child learn the alphabet with phonics? Surely they just learn that each letter makes a sound. If you show them a "b" and make a "buh" noise, won't they recognise "b" to be "buh" and not the actual letter? I'm specifically referring to when teaching children from a very young age when they won't know any better, like in the above video.