First the bad news: Apple Inc. may have resuscitated recorded music when it opened its iTunes online store in 2003. But the digital depot hasn't come close to rescuing the business. BTIG LLC analyst Richard Greenfield even expects unit sales of digital music will start to fall -- "for the first time ever" -- in the second or third quarter of this year. The result? "Calendar 2011 will be the worst year ever for the music industry in terms of unit sales," the analyst predicts in an update on Warner Music Group Corp.

That, of course, is after a string of years where anything worse became increasingly hard to imagine. Since peaking in 1999 with a retail value that the Recording Industry Association of America estimated to be greater than $13 billion, the domestic recorded-music business contracted 41% over the next decade to post a retail value for 2009 of $7.7 billion. Indications are it shrank a further 10% in 2010, although the RIAA hasn't yet released official figures.

Now the good news: Google Inc. is committed to picking up where Apple has left off. Or, more to the point, Google is committed to picking Apple apart by offering what sources consider an improved iMusic experience. This experience would no longer require consumers to store their music locally on devices individually loaded but, rather, allow them to access their music from any wired or wireless device with an Internet connection.

Initially, though, Google would have to persuade its customers to store their music libraries on a so-called sound cloud. And there, for a rental fee sources place between $40 and $50 a year, each customer would be issued a digital locker. Each locker, in turn, would serve as a repository for music obtained through legal or illegal means.

That's right. As some sort of amnesty-outreach program, one designed to kick-start Google's cloud-based service, previously pirated music would be allowed inside a customer's locker. Indemnification is, in fact, Google's secret sauce for devouring a good chunk of the online music business. "If it can tell all the pirates out there that they are forgiven, that no record company is going to come after them, that's a very big plus," says a source conversant with Google's business model.

Any guarantee of blanket amnesty would require Google to strike deals with the four major record companies -- EMI Group Ltd., Sony Music Entertainment and Universal Music Group, in addition to Warner Music -- to indemnify sound-cloud customers who upload pirated tracks to their lockers. It would also mean letting bygones be bygones and forgoing piracy penalties that, in the United States, begin at $750 per song.

However, after a grace period for each sound-cloud customer, Google technology could ensure subsequent additions to the customer's locker were all legally obtained. And, as a bonus, it could even assist in the conversion of legally but previously acquired content, like compact discs, to a cloud-compatible format. Although Google isn't ready to unveil its sound-cloud strategy, sources say it's getting close -- close enough, anyway, for its ambitions in music to play a role in the ongoing auction of Warner Music and the anticipated auction of EMI.

Valuing record companies has never been more difficult. Just ask Guy Hands, the founder of Terra Firma Capital Partners Ltd., whose private equity firm bought EMI for £4.2 billion ($6.8 billion) in May 2007. Early this month, on securing EMI as its sole lender, Citigroup Inc. effectively valued the asset at about half the price Terra Firma paid for it. What's more, there are those who believe the melting ice cube that characterizes the music business faces more heat.

Analyst Greenfield, for instance, believes the free fall in physical unit sales and weak touring environment are spilling over into music publishing. This second business of record companies has traditionally served as the industry's bedrock. That is, with its diverse revenue streams from radio, television, advertising and other sources, publishing not only insulated the majors from the vagaries of consumer taste but protected them from the vicissitudes of the economy.

But over its past three fiscal years, Greenfield reports, the publishing business of Warner Music has generated compound annual decline rates of 6% and 4%, respectively, in terms of adjusted revenue and adjusted Ebitda. The analyst also notes an acceleration of this trend in Warner Music's most recent fiscal quarter, with adjusted revenue dropping 15% and adjusted Ebitda falling 18%. Failure to reverse publishing's decline would no doubt mortally wound an industry many have already given up for dead.

Still, for all their problems, Warner Music and EMI are drawing or are expected to draw considerable suitor interest. It was only a month ago that Warner Music retained Goldman Sachs Group Inc. and Alan Mnuchin's AGM Partners LLC to auction itself and to pursue EMI. Yet the record company has drummed up indications of interest from more than 20 parties. Its stock has reacted accordingly, rising to around $6 per share from $4.72 the day before Warner Music confirmed its retention of financial advisers.

Some believe Warner Music shares still have a ways to go. If the company is taken over before Google goes public with its sound cloud, an analyst other than Greenfield contends the stock price could "easily be $7.50 per share." But if Warner Music holds out long enough for investors to process Google's music ambitions, this same analyst envisions a take-out price "closer to $12 or $13." Either way, his take on Warner Music is directionally opposed to Greenfield's assertion that investors should "be shorting the stock."

The plight of the music business has made its participants more receptive to an outsider like Google than they would have been in the halcyon days of vinyl and the heyday of CDs. An increasing number of them now accept they'll have to act on this receptivity, if only because the cost of letting piracy continue unabated has gotten too big for record companies to absorb. The RIAA credits the Institute for Policy Innovation with a "credible analysis" that puts the U.S. economic loss from the global piracy of sound recordings at $12.5 billion a year. Compare that, if you will, to the retail value of $7.7 billion that the RIAA posted for the entire domestic recorded-music business in 2009.

Piracy, moreover, doesn't just diminish record companies. The IPI goes on to estimate it costs the U.S. workforce 71,060 jobs and $2.7 billion in annual earnings. Federal, state and local governments get screwed, too, by an annual amount the IPI calculates to be $422 million at minimum. Statistics like these could make the indemnification strategy that Google wants record companies to embrace problematic for any number of constituencies. According to sources, though, the only major record-company holdout these days is Sony Music.

This isn't entirely surprising given the anti-piracy software that Sony Music's predecessor company, Sony BMG Music Entertainment, illegally placed on CDs in 2005. But the reluctance of Sony Music could also be the result of a competing cloud-based service that its parent company, Sony Corp., launched in December. The Sony service, with the unwieldy name of "Music Unlimited powered by Qriocity," is currently available throughout much of Europe and contains songs from the catalogs of all major labels. And, true to its parent company's obsession with marrying Sony software and Sony hardware, Music Unlimited requires an Internet-connected Sony device like a Blu-ray Disc player, Bravia TV, PlayStation3 or VAIO personal computer.

Americans, though, will likely regard Music Unlimited as more an alternative to Sirius XM Radio Inc. rather than a competitor to Google's sound cloud. As Sony stated on introducing the service, "The basic plan works as an infinite ad-free radio station and subscribers can listen to dozens of personalized channels -- categorized by genre, era as well as mood." It's priced at €3.99 a month, or roughly $65 a year, and is flanked by a premium offering that allows subscribers to create personal playlists for €9.99, or about $160 a year.

"Sony wants to be the big dog," a source says of this lingering obstacle to Google's firing up a competing service. But that may not preclude Sony Music from coming around once Google starts repatriating 70% of its rental fees to its sound-cloud content providers and keeping a mere 30% in exchange for maintaining digital lockers and running a cloud-based digital store. The math, after all, is extremely motivating.

Despite rampant piracy, record companies still put their domestic customer base at 200 million -- unchanged since the height of the CD era. So, assuming just half of this base rents digital lockers, that would be a $3 billion annuity to the record companies that Google stands ready to underwrite. Compare that, again, to the $7.7 billion in retail value that the RIAA posted in 2009 for the entire domestic recorded-music business. And recognize that, regardless of how the annuity is allocated, few costs would detract from the top-line figure.

Nonetheless, a music executive at a label other than Sony Music appreciates the record company's hesitancy. "I know some see indemnification as legitimizing piracy, as forgiving the very people who practically killed this industry," he says. "But our view is different; our view is how much are we making off all those pirated tracks today?"

To be sure, the overriding mission of Google is not to save the music business but to exploit it in a quest for software supremacy. Its real fixation is Apple, whose iOS software for mobile devices like the iPhone and the iPad competes with Google's Android operating system. These two platforms are vying to become to mobile devices what Microsoft Corp. software has been to personal computers. And while neither currently leads in the domestic market for smartphones -- that honor temporarily belongs to Research In Motion Ltd.'s BlackBerry, with a 31.6% share, as measured for the fourth quarter by comScore Inc. -- they're expected to dominate by year's end.

The fourth quarter also saw the Android platform, with a 28.7% share, surpass the Apple iPhone to take second place. It'll continue to grow, too, given the number of manufacturers that have adopted the Google-owned open-source system. But the iPhone, with a 25% share, remains a formidable competitor. Witness its recent foray with Verizon Communications Inc. into what had been Android territory.

Compared to Apple and Google, with respective market capitalizations of $330 billion and $200 billion, the less than $1 billion accorded Warner Music (the only publicly traded pure-play record company) strikes one source as "a rounding error." Yet he and others acknowledge that this rounding error, not to mention the other record companies, will figure prominently in any Apple-Google contest. "Google knows there's nothing stickier than someone's music collection," a record executive says. "It knows that if it can provide a quality music service, if it can let customers store and access all their music on any Android device, then it has a compelling proposition."

For Apple to cede its current edge in music functionality to Google is, of course, unthinkable. But after buying online music-streaming site Lala.com in December 2009, the cloud-based iTunes that many believe the acquisition would engender has yet to materialize. What's holding it back, most likely, is Apple's obtaining the same sort of indemnification from the record companies that Google is seeking. "That's why iTunes customers still have to store their music locally," a source explains. "Apple doesn't want to be sued for holding pirated tracks, and it can't indemnify copyrights it doesn't own."

So negotiations continue, as they have for more than a year, between the record companies and both Apple and Google. At this late stage, any breakthrough by one sound-cloud coalition seems likely to be closely followed with a breakthrough by the other. And the result will be that the long-suffering music industry winds up being the tail that's wagging not one but two very big dogs -- Apple and Google -- the smallest of which is still 5 times larger than sound-cloud holdout Sony.