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A music mogul should love this picture: frat boys and their dates at the University of North Dakota dancing on a beer-slick living-room floor to music blaring over a p.a. system. They are, after all, the music business's target demographic--18-to-24- year-olds in touch with the trends, loving the latest tunes. Yet this archetypal collegiate partyscape has turned into a music-biz nightmare. That's because no one is paying for the music.

Jason Zotaley, a 19-year-old pledge, downloaded the dance jams for free over the Internet. Zotaley estimates he has 1,300 songs on his computer, everything from classics by Van Morrison to the latest by the Beastie Boys. And he has never paid for a single song. "I don't know how legal that is," he says with a shrug, but free songs sure are "a good investment." His rap, techno and swing titles go directly from a laptop to the house's deejay booth. These digital music files have replaced compact discs entirely when it's time for the fraternity house to get jiggy.

Millions of teens and twenty-somethings like Zotaley have joined the digital revolution, downloading music from the Net and skipping that trip to Tower Records, thereby saving the $16.99 they would have spent on a CD. On college campuses that offer students fast T-1 connections to the Internet, up to 75% of students are music pirates.

This is a sour note for the $12 billion-a-year music industry, which is belatedly taking a long, painful look at its endangered business model. The industry is losing millions in revenue to the digital pirates, who use a readily available (and free, of course) software program called MP3 (Mpeg1 Layer 3) to receive and send music over the Internet. The pirated tunes have sound quality comparable to that of CDs, and can even be channeled through conventional stereo systems. "The Internet has made music so vulnerable," says Record Industry Association of America (RIAA) general counsel Cary Sherman,...