Although wide scale digital piracy of music has been with us since the inception of Napster in 1999, the severity of the problem has only been recently recognized by many in the record industry. At a recent music symposium in New York hosted by well known industry lawyer Steve Gordon, Sony's Vice President of Technology Strategies David Hughes suggested that some in the business did not "grasp the seriousness of the problem" until as recently as 12 months ago. Although the numbers certainly speak for themselves, many old guard music industry players simply viewed piracy largely as a temporary problem and not a massive transformation in an established business model.

Even though there is some controversy as to what exactly what is causing the declines, there is no question that CD sales themselves are plummeting. In the US alone, sales of recorded music have declined 17.5 per cent over the last 3 years, transforming an £8.1 billion ($14.3b) powerhouse into an £6.7 billion ($11.8b) hangover. Other music economies like Germany have seen even greater damage, with declines of over 30 per cent during the same period. Worldwide sales overall have experienced a 20 per cent decrease. (Curiously, the UK has remained quite resilient, holding steady at about £1.2 billion ($2.1b) since 2000, but that's another article!)

The problem has been recognized clearly by some from the beginning. The Recording Industry Association of America (RIAA) has led the charge to combat the problems associated with piracy since the 1990s. Its pivotal shutdown of Napster in a California courtroom in 2000 was an attempt to crush a file-sharing free-for-all.

But the result was far less neat. Soon after the death of Napster, decentralized P2P applications seemed to pop up everywhere.

The most notorious of these is Kazaa, currently owned by Australia's Sharman Networks. Using a highly decentralized FastTrack file sharing system that relies on user "nodes" to direct file traffic, Kazaa emerged as a multi-headed monster from Napster's relatively innocent ashes.

Meanwhile, various legitimate systems such as MusicNet, PressPlay and Rhapsody floundered, failing to gain widespread acceptance from consumers amidst thin selection and confusing usage rules.  It wasn't all the fault of the technologists, though: major labels, publishers and artists were simply too stubborn to permit wide scale use of their catalogues, resulting in embarrassingly empty selections. When content was licensed, it was often riddled with arcane usage restrictions that didn't make sense to the average music fan.

As CD sales continued to decline into 2003 and usage on P2P applications skyrocketed, various stakeholders gradually started smelling the coffee. More and more, artists, labels, and publishers were ready to come to the table. Newcomer Apple capitalized on this new sentiment with iTunes, which was finally able to offer its users relaxed usage rules that permitted liberalized track burning, transfers to an iPod, and usage on multiple computers. 

The response was, of course, enormous - at least for the legitimate side of the business. Mac-based music fans went nuts, downloading over 1 million tracks in the first week alone and 10 million during the first four months. Suddenly, everyone in the business had a success to talk about.

Apple CEO Steve Jobs soon brought the platform to the PC space, where the 99-cent download store continued its market dominance. Now, 50 million downloads later, iTunes is a major reason for an emerging digital music business model.

For the first time, record labels started to push content onto technology plays like iTunes instead of sporadically returning phone calls. It was suddenly not uncommon for an artist to demand that her tracks be placed on iTunes and other digital music stores. A new feeling crept into the industry, as executives developed the feeling that digital music distribution could work after all.

Well, sort of. iTunes has been a great success, but its numbers are only a tiny fraction of the amount of files transferred over P2P networks every day. And most in the industry have a relatively sober view of the business today, one in which 99 per cent of revenues still come from CD sales. CD-R sales have long since eclipsed pre-recorded CDs, as younger users burn shared files ad nauseum.

For most inside the business, it's a sobering reality, wrought with confusion about what the business will look like 5 years from now. But through it all, one thing is now clear: limiting the online space with onerous licensing restrictions and over-lawyering is not lining anyone's pockets with cash. Labels are ready to enable new technologies, and that includes new plays from legitimate P2P applications. Terri Santisi, Partner at KPMG Media and Entertainment Group, recently commented that "everyone is getting a meeting."

Given this new open attitude, why are stores like iTunes still suffering from a selection that is only a fraction of what can be found on P2P applications? The answer lies in major differences between the ways music is licensed in the digital vs. offline worlds.

In a traditional record contract, artists receive "points" based on total album sales. Points simply represent a percentage of the SLRP, or Suggested List Retail Price, of a CD. From a top level, an artist that moves a lot of full-length CD albums in stores is poised to earn a lot of cash.

In environments like iTunes though, a contract structure based on albums makes little sense. That's because iTunes is based on the 99-cent single sale, and prohibits artists from selling complete albums without also offering songs for sale on an individualized basis. In the new digital reality, consumers want to cherry pick their favourite songs and create customized mixes. If the record labels really had their way, this wouldn't be possible.

Although the album vs. single difference may seem like contractual minutiae, it is one of the major reasons why major artists like Metallica, Madonna, Linkin Park and The Beatles have so far remained on the sidelines. The irony is that file sharers have been downloading individual tracks from these artists from years on systems like Kazaa, Bearshare and eDonkey. But these superstars are nowhere to be found on legitimate services like Rhapsody, Napster, and iTunes.

Labels have continued to do their part, dedicating large amounts of resources to licensing music into the digital world. With the explosive revenue presented by ringtones, a greater motivating factor exists. Ariel Taitz, Atlantic Records Senior Director of Business & Legal Affairs, expressed the new proactive stance of the industry when he recently expressed a desire to "sell everything we can on the Internet, and have entire teams dedicated to this."

But is it too late for the wild, wild Internet to be tamed by the major labels? Clearly the industry arrived late at the party, and consumers have developed a vicious appetite for free goods. Still, P2P applications have weaknesses that can be trumped, including semi-reliable downloads, adware, spyware and bundled downloads. Consumers have expressed interest in paying for their favourite music, including up to £3 ($3.50) per ring tone. Labels have the right idea now, and could eventually transform their internal structures to meet the new digital reality. Unfortunately, these things take time.