Global digital sales grew by around 40 percent in 2007, the IFPI group said, but this was not enough to offset the sharp fall in CD sales, meaning the overall market is expected to be down around 10 percent for 2007.
As part of its response, the industry is calling on Internet service providers to take more responsibility for illegal file sharing by either disconnecting those who repeatedly upload music or preventing illegal tracks from being downloaded.
"ISP cooperation, via systematic disconnection of infringers and the use of filtering technologies, is the most effective way copyright theft can be controlled. Independent estimates say up to 80 per cent of ISP traffic comprises distribution of copyright-infringing files," the IFPI said.
Many ISPs have so far proved reluctant to engage on the matter, but the music industry is hoping this could change following a move by French gonvernment to block Web access to those frequently downloading music or films illegally.
The industry has also been boosted by a landmark ruling in Belgium which ordered a service provider to block illegal file-sharing -- although the company is appealing -- while in Britain, the government has said it could impose legislation if an agreed settlement between both sides cannot be found.
The music industry says it has been forced to turn to legal remedies after rampant Internet piracy rocked its traditional revenue model.
The IFPI said tens of billions of illegal files were swapped in 2007, with the ratio of unlicensed tracks downloaded to legal tracks sold at about 20 to 1.
Away from the legal disputes, the industry has seen encouraging signs from the growth of legal sales.
Global digital music sales were estimated to be approximately $2.9 billion in 2007, a roughly 40 percent increase on 2006, and single track downloads, the most popular digital music format, grew by 53 percent.
Digital sales now account for an estimated 15 percent of the global music market, up from 11 percent in 2006 and zero in 2003. In the United States, online and mobile sales now account for 30 percent of all revenues.
IFPI's complete Digital Music Report 2008 is available here.