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."

Still, albums must be sold, revenue must be generated.

Radiohead has so far declined to offer details about how many people have downloaded In Rainbows and how much they have paid. Late last week, however, the British music website Gigwise reported that Radiohead had sold 1.2 million copies of the album in its first week, citing "a source close to the band."

If that number is accurate, it means that the album went platinum in one week—no record label required.

Tim Quirk, vice president for music programming at Rhapsody, a joint venture between media giant Viacom and RealNetworks, said that when artists offer their albums for a suggested donation, the average price paid ends up being remarkably similar to what the record would have cost in a store.

Quirk has seen the music business from every angle. In the 1980s, he was the lead singer of the cult punk band Too Much Joy, which was briefly signed to Warner Music.

Although Too Much Joy had a few videos on MTV, the band never broke through commercially. Still, Quirk and crew earned a devoted following with releases such as 1987's Green Eggs and Crack and 1988's Son of Sam I Am.

Quirk is used to bucking the system. After hip-hop group 2 Live Crew was arrested for indecency, Too Much Joy immediately flew to Florida, and—in protest against censorship—played a show composed of selections from As Nasty as They Wanna Be, earning the band a night in jail on obscenity charges.

“We did it in the same club where they got arrested,” Quirk recalled in an interview. “We tried to get other alt-rock acts to join us (R.E.M., Sonic Youth, etc.), but no one would come. The idea was to see if the cops would arrest white suburban kids for singing the same words, while also protesting some fairly obvious and ridiculous First Amendment violations.”

“There was a three-day trial too, a few months later. The jury took five minutes to find us innocent, and said it would have been quicker, but some of them had to go to the bathroom. The D.A. in Broward County said he wouldn’t prosecute any more obscenity cases after the decision.”

After Too Much Joy broke up in the late 1990s, Quirk joined Listen.com "at the height of the internet boom" as a rock writer and musician-in-residence. In 2003, RealNetworks, which had been developing a streaming digital music service called Rhapsody, bought Listen.com. In August 2007, RealNetworks merged with media giant Viacom, which owns MTV and VH1.

Viacom's purchase of a 49 percent stake in Rhapsody was a major coup for Real, which now gains access to what Quirk described as Viacom's "massive marketing platform" of MTV, VH1, and their other brand outlets. Financial terms of the deal were not disclosed, and Quirk declined to offer details. But filings with the Securities and Exchange Commission show that Viacom will contribute cash and make a five-year commitment of $230 million to the venture, in addition to migrating Urge users to Rhapsody.

As Rhapsody's vice president for music programming, Quirk is the company's chief evangelist for the subscription model. But ever the musician at heart, he also has a side project called Wonderlick with Too Much Joy's guitarist, Jay Blumenfield. Like Radiohead, Quirk and Blumenfield give their music away for free online and simply ask for donations. And it's working.

"I'm making more money by giving away my music for free than when I was a Warner Music recording artist," Quirk, a vocalist, said. Sometimes, he said, hardcore Too Much Joy fans pay as much as $150 to download a single album from the band's website. The fact that fans will voluntarily pay so much for an album has a lot to do with the goodwill that the bands generate. This is what Radiohead is shooting for.

The key to understanding the changes rocking the music industry, Quirk argues, is to see that the value proposition inherent in record sales is changing.

The idea of owning music is heavily entrenched in popular culture, as evidenced by the zeal with which music aficionados build and maintain their prized record and CD collections. But the arrival of broadband internet and the MP3 digital music format has created the possibility of a new way of thinking about music ownership, Quirk argues.

"Music is moving away from being a product and moving toward becoming a service," Quirk said. In other words, with access to massive databases of music that are distributed over the web, consumers no longer need to own individual albums and songs. They can simply access songs they want to hear at any time from a master database, for a simple monthly price, kind of like getting cable TV. This is the subscription model championed by Rhapsody.

Here's the deal Rhapsody is offering: For $15 per month, Rhapsody users have access to 4.5 million songs from virtually every artist. The company is adding 10,000 songs per day to its catalog, Quirk said, adding that over 1 billion songs a year are played on Rhapsody.

Quirk acknowledges there are some artists who have refused to license their music to Rhapsody—or anyone else. But the number of holdouts is shrinking every year. On Monday, Led Zeppelin announced that after years of resisting the lure of online distribution, it would offer its songs over the web beginning with an exclusive deal with Verizon Wireless to sell ringtones and other mobile features.

The subscription model has also been championed by Rick Rubin, the Buddha-like co-chairman of Sony/BMG's Columbia Records, who has argued that it is the only realistic alternative to the "99 cent" model championed by Apple, whose iTunes music store and iPod music player currently dominate the digital music market.

Last month, in a widely discussed article, Rubin, whom the record companies have apparently anointed as their savior, told Lynn Hirschberg of the New York Times that "the world has changed. And the industry has not." He said the industry's salvation would come through the subscription model.

"You'd pay, say, $19.95 a month, and the music will come anywhere you'd like," Rubin told Hirschberg, including mobile devices. "The service can have demos, bootlegs, concerts, whatever context the artist wants to put out. And once that model is put into place, the industry will grow 10 times the size it is now."

Rubin may be exaggerating with that last prediction, but there is no doubt that the industry must find a new business model if it is to stave off disaster. For many, the subscription model, which treats music as a service, not a product, could be the last best hope. Rhapsody's Tim Quirk said Apple's 99-cent model represents the illusion of a solution, but because it still treats music as a product, it is not sustainable.

"iTunes is yesterday disguised as tomorrow," Quirk said. "For the past several years, it has given the record industry the false hope the transition from product to service can be staved off. The distinction between music you own and music you can listen to at any time is being erased."

Quirk said the subscription model dramatically increases the potential exposure for lesser-known, independent bands. Nearly 49 percent of the music sold at big retail chains like Wal-Mart consists of the top 100 bands in the world, Quirk said. In contrast, 23 percent of music played on Rhapsody is from the top 100 bands in the world.

In other words, more than two-thirds of the music that people listen to on Rhapsody is coming from independent, or lesser-known bands. This bodes well for the health of the industry, Quirk argues, because it means that young bands have access to vastly more consumers than ever before. Likewise, consumers have access to vastly more new music than ever before.

"The major labels had a business model which has been eviscerated and is now in free fall," said Bob Lefsetz, an expert on the record industry. Lefsetz is an entertainment lawyer and former record company executive who has been publishing The Lefsetz Letter, an industry newsletter, for more than 20 years. Lesfetz said it should come as no surprise that Radiohead declined to renew its contract with EMI, which ended with 2003's release of Hail to the Thief.

"The record companies are thugs," Lefsetz said. "It's like organized crime. In the old days, they used intimidation and bullying to control the means of distribution. They beat up D.J.'s and rappers in the back alleys of clubs, and never paid royalties accurately, or on time."

"They can't do that anymore," Lefsetz said.