At first glance, the vital signs of the music industry don’t look so good. According to the latest figures from the International Federation of Phonographic Industries, total physical unit sales in the first half of 2005 were $13.2 billion, down from $13.4 billion a year earlier. And this continues a seemingly endless trend of losses for music companies.

But these latest aggregate figures hide a different trend: online music has experienced phenomenal growth: roughly 350 percent since 2004. In this industry segment, sales skyrocketed from $220 million in the first half of 2004 to $790 million a year later. Dominated by Apple’s iTunes Music Store, online music purchases now account for six percent of overall sales, up from just two percent a year ago.

Understandably, the industry is quick to emphasize this good news. “The digital music boom is continuing and it is growing at an exciting pace for the music industry, for online retailers, and for consumers,” IFPI Chairman and CEO John Kennedy stated in a press release accompanying the results. “More and more people in a growing number of countries are turning to the new legal ways of downloading music on the Internet or via mobile phones.”

Even some at the file-sharing companies admit defeat. “The music industry has won not only the online music battle, it’s won the war,” says Wayne Rosso, founder of the much-assailed Grokster file-sharing system, and now chairman of Mashboxx, Grokster’s new owner.

Indeed, the music industry’s five-year legal crusade against the makers of file-sharing systems and users themselves appears to be resulting in a radical shakeup. In early September, an Australian court ruled that Kazaa, a peer-to-peer file sharing company founded by the same programmers who went on to create voice-over-Internet firm Skype, had enabled and authorized copyright infringement. The judge ordered Kazaa’s parent company to modify its software application to reduce the infringement – and to pay 90 percent of the court costs for the plaintiffs, who included the likes of Warner, Sony, and Universal.

Earlier, the U.S. Supreme Court’s ruling in June against Grokster spooked the remaining file-sharing companies into radically reworking their business models – or going out of business. Grokster itself was sold to Mashboxx, a company that provides industry-sanctioned files to file-sharing networks. WinMX, a popular file sharing service, has gone out of business. Meanwhile, eDonkey – another leading P2P company – will soon begin charging its customers for songs, according to company founder Sam Yagan.

Even BitTorrent, which developed a truly decentralized method of swapping files and has been the bane of music companies, may be changing its tune. The company recently took in $8.75 million in venture financing – and venture capitalists don’t usually throw that kind of money at a company that’s pursuing piracy as a business model. “BitTorrent will become the ideal platform for both independent publishers and the world’s leading media companies,” said BitTorrent creator Bram Cohen in a statement about the funding.

Given this evidence, it seems like a clear victory for the music industry in online music. What’s more, such a proposition would have been unthinkable six years ago, when Napster burst onto the scene, introducing the idea of free music to millions of online music fans – and seemingly sounding the death knell for traditional music labels.

But the industry’s legal efforts to thwart peer-to-peer file sharing are clearly having an effect on the companies that offer such software. And they’re affecting file-sharing traffic as well. According to Eric Garland, CEO of BigChampagne, a company that monitors peer-to-peer traffic, overall traffic growth on these services is slowing. “The growth curve is pretty glacial at this point,” he says.

In fact, the average number of simultaneous peer-to-peer users for September 2005 was 9.3 million, down from 9.6 million in August.

Still, Garland believes that while the companies offering this software may disappear or go legit, peer-to-peer software won’t go away – and it may in fact become more user-friendly. P2P companies made revenue via the ads they bundled and sold with the software, Garland points out. If the companies go out of business, other ad-free variants of P2P software may continue to grow in popularity.

“Once you take the profit incentive out of the software, you remove all the things like spyware and adware that companies have inserted into the products,” Garland says.

So while this may be a moment of victory for the music industry over the software geeks, it may also be a transitory one. Already, fissures are showing between the music industry and Apple, as evidenced by the recent sniping in the press between Apple’s Steve Jobs and Edgar Bronfman, CEO of Warner Music, over iTunes pricing plans.

Bronfman is looking for more money, or at least the right to control the pricing, while Jobs is adamant about keeping the price of a song on iTunes at 99 cents. And a world in which consumers are able to select ten individual songs in 99-cent increments instead of buying a $17 album on CD may not be a bright one for the music industry.

 ”If this is a victory, it’s a Pyrrhic victory,” says Jim Griffin, CEO of Cherry Lane Digital, a consulting business that links entertainment and technology. “It’s a victory in an arena that’s very different than the music business as we know it. It’s a victory for granularity, and granularity isn’t really a victory for many businesses.”

At this point, however, the music industry will likely take victories wherever it can find them.