I am familiar with this problem, as I have reinstalled FFVII on so many different PCs and operating systems that my discs are wearing out.

I'll have to look for my notes, 'cause it's been a while since I've done it on XP, but I do remember the disc reading problem.

In the meantime, take your disc out, make sure it's clean, and that your computer can read it. Rather than using the start menu to open it, try using the disc's auto-run. If you use the auto-run menu to start the game, it means that the computer can read the disc, and can sometimes circumvent that sort of problem.

Also, are you doing a Maximum installation (all files except vids play from the PC)?