In the stories you see on my site, I just have students go to the Google Docs program, and each one writes one line of the story. They then go to ArtPad, a delightful little online painting application, and illustrate their sentence. I then just copy and paste the story and the url’s to their paintings onto my website.
However, there are so many different applications out there right now (and brand new links to many of them — Skrbl, WriteWith, Zoho, Writeboard and YourDraft — are listed in the Collaborative Story category) you can do this kind of project a number of ways.
I just put these last five collaborative writing tools on my site, and you can be sure that many more will be coming down the pike.