The old maxim that "you can't compete with free" has been thrown around time and time again in the piracy argument.
Sometimes, though, piracy is not just about price.
People don't want DRM (including Bill Gates), and there are still no legal means to download DRM-free music. (Ok, I should clarify - eMusic offers DRM-free downloads and is apparently now the second largest online retailer of music - but it doesn't include most mainstream music or most (any?) of the "major" labels.)
People also don't want to wait for arbitrary release dates, and retail versions of albums are quite often available on the Internet well before the release. For example, Fred Wilson has an advance copy of the new Arcade Fire album many of us are anxiously awaiting. (That's one thing I definitely miss from my WHCL days). The album doesn't come out until March 6th, but it's already available for download on the filesharing networks. Thing about the choice that the record industry gave the rest of us - download it DRM-free today, or wait a month and a half to pay for it in a format that limits how we can listen to the album.
You can compete with free - but not when you are more expensive and provide less value.
Microsoft is experiencing this very issue with its launch of Vista and Office 2007 - unsurprisingly, copies of both have been available on BitTorrent since they were released to manufacturing in November. Digital distribution has eliminated many of the necessary logistical reasons for having such a lead time, and word of mouth marketing on the Internet helps allay some of the marketing issues.
That said, there's still hope for the record industry as long as they get their act together. There is obviously still considerable demand for their product, which is no small feat considering all the entertainment competiting for our limited attention spans today.
Fortunately, it looks like the record industry is slowing realizing that DRM is bad. RealNetworks has been pleading for the labels to "move away from DRM", and rumors have been circulating most of the month that a major label (EMI) is at least thinking about taking the MP3 plunge.
There is even talk that the record industry may be considering blanket licenses to legitimize filesharing. The only problem is that it sounds like they want a compulsory tariff instead of the voluntary, contributory system that the EFF once suggested.
I agree with Michael Arrington that replacing DRM with a music tax is not the right answer - but the key element for me is that it is optional. If the record industry offered a subscription plan with DRM-free music, I bet most of those 59% of Americans would subscribe - even if it was $20 or $25 per month.