As musicians and record executives descend on New York for the annual CMJ conference this week, the specter of Radiohead looms large.

The decision by the English rock band to offer its new album for free online has spooked the recording industry. It will be a major topic of discussion at the conference, as experts gather to discuss the future of the business and hundreds of bands take over the city’s clubs.

The music industry is in the midst of a grinding transformation. The record companies are fighting desperately to maintain their grip on music distribution, as high-profile artists increasingly look to cut them out by selling directly to fans over the internet.

Portfolio.com talked with several music executives and other industry experts about the digital challenge. Almost universally, experts say that Radiohead’s decision to circumvent the major labels is a milestone, illustrating how perilous the situation has become for the labels.

Many industry experts argue that the record labels face a stark choice: Either adapt to the changing environment by embracing new digital distribution schemes—like the subscription model—or die.

One of the most respected critics of the major record companies is Terry McBride, the chief executive of Nettwerk, Canada's biggest independent record label and management agency. McBride, who became famous by starting the Lilith Fair in 1997, is considered a visionary in the recording industry. Nettwerk's current and former artist roster includes Barenaked Ladies, Dido, Sarah McLachlan, Avril Lavigne, and Sum 41. McBride's most audacious move has been convincing the Barenaked Ladies to release individual tracks to the public, allowing fans to create their own mixes of songs.

He argues that the recording industry has failed to capture the potential revenue to be generated from digital music distribution.

McBride said he fully supports Radiohead’s move to cut out the major record labels by offering their newest album, In Rainbows, for whatever fans choose to pay.

"They will make millions," he said.

McBride is particularly vocal about the need for bands to develop relationships with fans through online networks. He says he wants to use websites like MySpace and Facebook to act "as social filters and be the marketing and promotional teams behind great new artists." McBride argues that the most effective way to market bands will be to associate them with what he calls "social causes"—essentially marketing themes that consumers can identify with—much as Radiohead has positioned itself against the record industry oligopoly and U2 has cloaked itself in the fight to end African poverty.

"It's all about having a connection," McBride said. "Fans these days need to see artists that they support take up and truly support causes they themselves can relate to. When you do this, you help turn your fans into goodwill ambassadors."