The music industry is con­fronting a challenge that would severely tax any business group: how to compete profitably with some­thing that's being given away for free.

That's the hurdle facing musi­cians and record companies, as they try to create a new business model that will tackle the rampant free downloading of music on the Internet.

Through a combination of liti­gation, education, and what it considers attractively priced alter­natives, the music industry feels it may be turning the corner on a problem that has severely dented its revenue and profits.

As the parent of any teenager knows, free music file sharing is enormously attractive, especially to younger generations. Starting with the creation of Napster Inc. in the 1990s, computer users have been able to tap into the on-line music files of other computer users worldwide, and exchange compressed electronic versions of millions of tunes.

A whole generation has grown up collecting music without having to plunk down $20 for a CD. They've been able to create their own compilations, burn their own CDs, and check out new music they'd never be able to find in a re­cord store.

While many music aficionados still selectively buy CDs, some never, ever, pay for the music they consume.

That's knocked 20 per cent — or about $250-million — off annual retail music sales in Canada alone over the past three years, accord­ing to the Canadian Recording Industry Association (CRIA).

And music collectors have few qualms about "stealing" music. A recent study from Solutions Re­search Group Consultants Inc. in Toronto showed that only 31 per cent of Canadians between 12 and 24 feel that downloading songs off the Internet is theft.

Almost seven million Canadians have already downloaded music off the Internet, the study shows.

Litigation by the Recording Industry Association of America (RIAA) to shut down free file sharing, based on arguments citing copyright violations and intellec­tual property rights, has been going on since the early days of Napster.

While some bands — most no­tably heavy metal rockers Metal­lica — joined the record companies' legal efforts to kill off free file sharing, many others sup­ported the new technology as an effective means to distribute their music directly to fans.

The legal victory in 2000 that led to the eventual closing down of Napster was Pyrrhic at best. Im­mediately in its place popped up a whole new league of similar sys­tems, including Kazaa, Acquisition, Morpheus, LimeWire and the like.

While the legal battles continue — the RIAA said last month it will now prosecute individuals who il­legally trade songs on the Internet — critics say the industry is mis­guided in taking such a litigious approach.

"There is not a shadow of a doubt that the [record] labels have been focused far too much on try­ing to stop the inevitable," said Phil Leigh, a digital media analyst at Florida-base brokerage Raymond James Financial Inc.

He likens the record company's attitude to that of the motion pic­ture producers two decades ago when they filed suit against Sony Corp. to try to block the spread of the videocassette recorder.

The producers said the new device would lead to copyright violations and cut into movie attendance. Eventually the U.S. Supreme Court threw out the case, but only in a very close split deci­sion.

Ironically, "the studios now make more money off of renting videos than they do off box office [revenues]," Mr. Leigh said. "When you stop and think about the fact that the media companies almost kept the VCR out of the hands of consumers in the U.S., that's fairly frightening."

His message is that in the long run, embracing new technology will be far more productive than trying to block it.

The record industry has recog­nized this, says Brian Robertson, president of the CRIA, and is mov­ing as fast as it can to create a new environment that will encourage payment for downloads.

Essentially, the idea is to get music fans to pay for legal down­loads of high-quality licenced music.

By mid to late September, the CRIA will have completed negotia­tions to set up a framework for paying music publishers and com­posers whose music is down­loaded on pay-for-play systems, Mr. Robertson said.

That will allow Canadian-based services to start operations, he said, and allow U.S. systems such as Apple Computer Inc.'s iTunes "music store" to expand into Canada.

Why has it taken so long to get things organized to compete with the free downloads? "A lot of it has to do with creating a whole new business model," Mr. Robertson said.

The old system, where rights owners are paid a few cents for each recording sold in a store, has been in place for a century, he said. "We're having to reinvent the process."

The record industry's energy was initially diverted to fight Napster on legal grounds, he admitted, and the companies were also taken aback by the speed with which new technology allowed il­legal downloading to spread.

"We seemed to go almost over­night from no Internet piracy to totally widespread out-of-control piracy," he said.

But it's one thing to allow paid downloading of music and to es­tablish a means of compensating the artist and record companies. It's another to make the system economically viable in the face of free downloads that aren't likely to fade away.

"The key question is, how do you compete with free?" said Mr. Leigh of Raymond James.

He thinks the key will be quality and reliability, something that is diminishing in the free downloading scene. For example, he said, "Kazaa has an abundance of pop up ads, it's full of spyware, it has inconsistently performing soft­ware, decoy files, viruses, and un­reliable connections."

And increasingly, at least for U.S. users, "some of the hassles will be nasty letters from the RIAA and the possibility of getting sued."

Still, early attempts to create pay-for-play file sharing in the United States were not very suc­cessful. The systems were gener­ally backed by the record labels, and were hampered by narrow playlists.

A huge ray of hope was injected into the industry, however, when Apple launched iTunes in April.

The iTunes system has appar­ently hit many of the right buttons, with a 200,000 song playlist, 99 cents (U.S.) per tune pricing, free previews, and some exclusive ma­terial.

Apple claims users downloaded five million songs in the first eight weeks after the launch, despite it being limited to Mac users in the United States. Chief executive offi­cer Steve Jobs declared that the success "clearly illustrates that many customers are hungry for a legal way to acquire their music on-line."

Mr. Robertson suggests that Apple's pricing, the simplicity of paying per song, and the quality of the music files seem to be the key to success and a model that others will emulate.

"It's been a bit of a beacon to the other services," he said.

When Apple broadens its serv­ice to the Windows environment — expected some time later this year — the potential audience will expand dramatically. Canada will be added to the Apple system when the CRIA completes its ne­gotiations in the fall.

At that time, Canadian competi­tors will also enter the field. One that is ready to go is PureTracks, a pay-for-play service developed by Toronto firm Moontaxi Media Inc.

"All the signals are looking very positive," said Moontaxi founder Alistair Mitchell. "We're still plan­ning our launch for the fall."

The PureTracks content will in­clude material from all the major Canadian record companies and the bigger independent labels, Mr. Mitchell said. The "indies" are cru­cial, because "a big reason why people go on-line to look for music is to find stuff that is new, emerging, niche repertoire," he said.

While the company had origi­nally considered charging a monthly subscription for down­loads, market research clearly showed consumers much pre­ferred a per-download pricing structure.

Apple's success with its 99-cent-a-tune system underlined that "à la carte" was the way to go, Mr. Mitchell said. It also showed there was clearly a business case for a high-quality pay system in competition with free downloads. Apple's experience "told us it was worth our while to be making this happen," he said.

Despite the apparent success of Apple's iTunes, there have also been bumps on the road that un­derline just how difficult it is to revolutionize the way the music industry works. For instance, some bands — including Metallica and the Red Hot Chili Peppers — have refused to put their songs on iTunes because they don't want individual tracks downloaded. They want to maintain the integ­rity of the album format.

Still, the advantages of moving to on-line distribution are huge, and not just for music fans. Record companies can save dramatically on manufacturing, distribution and inventory costs by using the Internet, there are no minimum production runs, and no returns from retailers. And it allows them to exploit their back catalogue of music that is essentially "gathering dust in a warehouse," as Mr. Rob­ertson puts it.

Eventually, on-line sales should help fill in the financial gap cre­ated by the lower traffic in the retail stores, Mr. Robertson predicts. And he thinks in-store sales will improve if the industry can entice buyers to the physical product, by including more DVD material with CDs, along with bonuses and con­cert tie-ins.

At the same time, the CRIA will continue to try to convince music lovers that buying music, rather than downloading it for free, will keep the industry alive.

While the industry has been reluctant to adopt the heavy-handed legal approach used by its coun­terparts in the United States, Mr. Robertson does not rule out using that tool in the future.

"We are trying to find the bal­ance between education and in­timidation, which is the litigation approach," he said. "We're still seeing if education is enough here, or whether we need to go to the next step."

Over all, Mr. Robertson predicts a much healthier music industry in the coming years, with far less use of illegal file sharing.

Not everyone is quite so opti­mistic. Tom Vassos, an IBM Can­ada Ltd. consultant and e-commerce teacher at the Univer­sity of Toronto, says the profit pie is going to shrink for the music business over the long term, de­spite the changes.

"I don't believe there is going to be a magical revenue model that is going to get them back to the profit projections they [had] in the past," he said.

The record industry just doesn't have control any more, Mr. Vassos said. "The power has totally shifted, from the companies that own the intellectual property, to the Internet."

The music business is one of the most profoundly changed industries in the world as a result of the Internet, he said. "It is just so difficult to change the entire business model of an industry that has re­ally operated the same way for decades."