Napster's party is over, but the internet still poses a serious threat to music industry

The entertainment giants are suing music-swapping groups out of existence

It might be the death of a dream for Napster but for the major record companies, the nightmare is anything but over.

The decision in an American court late on Tuesday to block the sale of Napster's assets to German media group Bertelsmann dealt a mortal blow to the trailblazing file-swapping service. Napster has been forced to axe all its 42 remaining employees, including founder Shawn Fanning and the business now faces Chapter 7 liquidation.

Judge Peter J Walsh cited complaints from record labels and songwriters as well as the conflicting loyalties of Napster's chief executive, Konrad Hilbers. There were concerns that Bertelsmann would have been given preferential treatment over other creditors.

Napster's remaining workers enjoyed one last pizza party before shutting the enterprise down. One employee posted a final image of Napster's mascot cat logo on its web site with the message "Ded (sic) Kitty." Outside Napster's headquarters, disillusioned staff trudged off into the Redwood City sunset, carrying with them a few personal belongings in boxes.

The ruling marks the end of the three-year Odyssey of the company that became the bête noire of the music industry with a loyal following of 60 million devotees. It also represents a serious blow to Bertelsmann, which had invested $85m in Napster in an attempt to relaunch it as a paid-for service.

The collapse represents something of a hollow victory for the major record companies. The file-swapping industry has moved on rapidly since Napster attracted the legal wrath of the music majors. And Napster had in effect been offline since last July. Rivals such as Gnutella, Morpheus and Kazaa are more slippery because they have no central server which the lawyers can target. Instead the content resides only on the hard discs of the individual users.

File swapping has also spread beyond music and is now targeting movies. Broadband technology now means a film can be downloaded from the internet in little more than an hour from sites like MusicCity.com and Grokster.com. Quality is good and it is free.

As Hank Forsyth, a media analyst at Dresdner Kleinwort Wasserstein, says: "You've got a whole generation that thinks content should be available for free. And they're going to do that for as long as they can."

Simon Baker at SG Securities agrees, saying: "The whole industry of file sharing is at a crossroads in its evolution. They are already moved to non-central systems that are hard to shut down. Kazaa, for example, is incorporated in the South Pacific where there is no copyright protection."

However, it is open to debate whether the digital downloading of music is the major cause of the music industry's decline. There is no doubt that the industry is struggling. Figures released by the Recording Industry Association of America last month showed a 7 per cent fall in CD shipments in the three months to June.

Recent data from the British Phonographic Industry, which represents UK music labels, showed that sales of recorded music in Britain in the April to June quarter fell by 15.4 per cent on the same period last year.

The International Federation of the Phonographic Industry, which represents 46 national groups, says piracy of compact discs is a bigger problem than digital downloading. It says illegal manufacture of pirated CDs is now a $4.6bn-a-year industry. The worst countries are in the Far East and Eastern Europe.

The IFPI also says that internet downloading is a particular problem in countries with high penetration of broadband technology. These include the US, Canada and Germany, whereas take-up in countries like the UK and France is lower. But as broadband becomes cheaper and more accessible, it is certain to increase.

Other problems include the economic downturns in major music markets such as the USand Japan. Another important factor is the paucity of blockbuster acts. EMI's release schedule is a case in point. Though the new album from Coldplay has been selling well and entered the US charts at number five yesterday, EMI is relying on new albums from the likes of Atomic Kitten and Blue in the run-up to Christmas. It is also plundering its back catalogue with a Rolling Stones 40 Licks double CD complication, another Best of David Bowie CD and a Blondie Greatest Hits.

The music industry is tackling the download problem in two ways. First, it is trying to sue the file-sharing industry out of sight. Second, it is trying to develop its own subscription models whereby customers will pay a monthly fee to download a limited number of tracks.

Legal action includes a move against Listen4ever, a China-based music-swapping service. It disappeared last month after the industry's biggest labels, including Sony, Warner Music and BMG, sued four of America's biggest internet traffic carriers rather than Listen4ever itself.

The lawsuit demanded that Sprint, Cable & Wireless USA, WorldCom's UU-Net and AT&T Broadband block any traffic to and from Listen4ever.com.

Also last month, the Recording Industry Association of America filed a suit against Verizon, the telecoms company that is part owned by Vodafone, in an attempt to force it to reveal the identity of one its customers, which the RIAA claimed was pirating music files.

As well, the music majors won't talk about it but they are considering inserting a kind of virus into a file that means it will have a background hiss, or only play a loop of the chorus.

Finally, there are the music companies' own online music services that are gradually being established. MusicNet is controlled by EMI, BMG, AOL-Time Warner and Real Networks, a US technology company. Its costs $9.99 a month for 100 downloads. So far subscribers can only access 100,000 tracks from the participating labels but the service hopes to sign major licensing deals by the end of the year.

Pressplay is offered by Sony and Universal Music. A subscription costs $9.95 for unlimited downloads and streaming. But both Pressplay and MusicNet are only available in the US so far, and neither will release subscriber numbers.

In the UK, HMV will become the first British retailer to launch an online music subscription service later this month. Visitors to the web site will be able to pay £4.99 a month to download up to 60 tracks. Alternatively they can "burn" five tracks a month on to CDs.

Whether those will stop the downloading is uncertain. Hank Forsyth at Dresdner Kleinwort Wasserstein believes a market exists for buying online from the legitimate source. "If you go to the official source it is reliable and of decent quality. You won't download something and then find its got the sound of someone singing in the shower on the background. If music companies could offer webcasts of concerts and backstage interviews it would add to the appeal."