Movie and music executives are focusing more than ever on refining their business models for online distribution. Their goal: to offer something that's better than free so file-swappers who turn to their services are compelled to stay.

As long as there are people with little disposable income, illegal file sharing will persist, Warner Bros.' Antonellis says.

Executives at the Digital Hollywood conference in Los Angeles last week agreed that with further advances in copy-protection and rights-management technologies, the continued growth of broadband, and a lot of consumer education, legitimate online services soon will be able to compete with free peer-to-peer competitors. They'd better be. So long as there are students and others with little disposable income, illicit file sharing is likely to persist, says Darcy Antonellis, executive VP of distribution and technology operations for Warner Bros. "We have to be conscious of that threat and the availability of that content in the marketplace," she says.

Progress is being made. Last week, online music pioneer Musicmatch began offering 99-cent downloads with minimal usage restrictions, similar to Apple Computer's iTunes but for Windows PCs and Macs. The service lets customers play tracks on up to three PCs simultaneously and burn playlists onto CDs up to five times. Other services have much more stringent restrictions, including preventing files from being played on additional PCs or being burned to CDs at all.

Musicmatch CEO Dennis Mudd says he has waited years for the major music labels to offer viable terms. "We weren't going to come out with a download service until we could get these kinds of licenses," he says. "The music business is in a crisis, and the labels are acting more aggressively in order to turn things around. Legal digital-music distribution is a key part of the solution."

Meanwhile, major peer-to-peer file-swapping companies, which recently formed a trade group called P2P United, last week revealed an industry code of conduct. They also called on Congress to repeal the movie and music industries' right to seek subpoenas of file-swappers under the Digital Millennium Copyright Act and to spearhead negotiations between the entertainment and peer-to-peer industries that could lead to the file-sharing sites becoming part of the music and movie industries' revenue streams.

That's unlikely in the short term. Movie and music execs cite unpredictable quality as a disadvantage for file-sharing networks. And the fact that broadband is necessary to access movies online has given studio execs the luxury of time. But as the number of broadband homes approaches critical mass--Forrester Research estimates that 15.6 million U.S. households have broadband connections, on the way to 62 million by 2008--movie executives also want to ensure that there are easy-to-use, attractively priced options in place to counter the counterfeiters.

One company, PaymentOne Corp., is in talks with labels and studios to help them overcome consumers' reluctance to form new billing relationships by letting music and movie buyers be billed on telephone or Internet service provider bills. PaymentOne has agreements with 1,400 phone companies and ISPs, CEO Joe Lynam says.

As the music and movie industries wake up to digital reality, customer satisfaction is becoming an obvious competitive weapon. "We're not going to compete on price," says Tyler Goldman, VP of business development for Movielink LLC, a year-old movie-download service backed by five of the major film studios. "We need to develop a great user experience."