June 11, 2007  -- "Free porn" just might be the two most exciting or frightening words in the English language, depending on your point of view.

And they're especially threatening to the adult film industry, which has made billions through the sales of DVDs, videos, and sex products.

After two decades of phenomenal growth in profits, the porn industry is facing some major challenges as its X-rated DVDs and Internet content lose out to free videos and photos distributed by amateurs on the Web.

Sales and rentals of adult DVDs fell 30 percent in the last two years and sales of Internet-based porn, while still growing, have started to plateau, according to Adult Video News, an industry trade publication.

"The DVD market is a battle that we're losing," says Drew Rosenfeld, the creative director of Hustler Video Group. "Looking back historically, we're at less than half in numbers. Even a line like Barely Legal, which is our hero brand, used to be off the charts and it's gone down to a third of what it used to be a few years ago."

But pornographers will keep trying to adopt changes and hoping to make a buck. "I don't really think that there is less money to be made because of free content," says Drew Rosenfeld, the creative director of Hustler Video Group. "We're making important changes, from hard DVDs to video on demand and we're focusing a lot of production for Internet purposes first. In the past, we've put it online 90-100 days after we sell it on DVD. Now we're shooting it for the Web, which is less expensive for us and the consumer."

Longtime observers of the industry are more pessimistic about its prospects. "Why buy it when you can get it for free on the Internet," says Luke Ford, an industry gossip columnist, comparing pornography to the plight of newspapers losing readers to the Web. "There is less and less reason to pay for porn because there are plenty of free two to three-minute clips out there."

Although many of the big companies, such as Vivid Video and Wicked Pictures, offer free clips to entice viewers to buy the full movie online, Ford claims that only one in a thousand viewers actually whip out their wallets.

Ford thinks that some of the changes planned by the industry, such as video-on-demand, higher-quality design of the DVD boxes and mobile phone cybersex, will not make any difference to their sagging profits. "It doesn't matter what the industry does -- it's screwed in terms of profitability," he say. "There is a ton of free stuff floating around and the amateur stuff -- people filming themselves in their bedrooms and posting it online -- is not going to go away. It will just keep growing."

One of the entrepreneurs taking advantage of those changes is Steve Yagielowicz, a columnist for industry newsletter Xbiz and a porn Webmaster. He runs several Web sites with free content, including Amateurs Guide, which features free thumbnail photos and movie galleries of amateur porn video. Yagielowicz earns money by driving traffic to his wife's amateur site, which features paid content. And as an affiliate of larger porn producers, he earns commissions by featuring their content on his site.

"There must be 50,000 affiliates out there," explains Yagielowicz. "They get free content, usually free hosted galleries or 15-second teaser clips, from Vivid or another big company and post it on their site. And if someone likes that gallery and they click through and join the Vivid Web site, the affiliate gets a cut."

And some in the industry are borrowing methods from Wall Street. Francis Koenig, who once ran the New World Partners hedge fund, launched AdultVest last year. The hedge fund specializes in matching investors with adult entertainment companies. "We are making a market where there was none before," says Alan Ramer, the fund's director of business development.

Investors who qualify (earn an annual income of $200,000 a year, have a combined household income of $350,000 a year and have a net worth of $1 million) can put their money into several funds. The Libor Fund, which launches next month, will specialize in financing adult clubs. "This is a new model -- to promote a market in the adult industry that wasn't there before."

Porn has almost always been at the forefront of technology, adopting video, DVDs, the Internet, e-commerce, online payment, and digital TV long before the mainstream entertainment world. But as the supply of X-rated content keeps increasing, the demand for free and inexpensive porn will keep growing, rendering the industry less able to charge for its products.

One technology that some in the industry are banking on is mobile cybersex, pornographic clips to be viewed on cellphones. Industry estimates project the U.S. market will reach between $500 million and $1.5 billion by 2009.

And researchers have noted that the increased privacy of cell phones compared to computers could benefit the popularity of adult content.

"Anecdotally, we have observed that users often consider their cell phone as a very personal and private device; perhaps even moreso than their computer -- the probability of others discovering their search behavior (through cached pages, auto-completion of query terms or URLs) is smaller," wrote Maryam Kamvar and Shumeet Baluja, computer science professors affiliated with Google.

But many industry veterans don't hold out much hope for mobile cybersex, arguing that the screen is too small and that major carriers are unwilling to carry adult content.

Hustler's Rosenfeld is also skeptical. Although he says he was just given an order to start creating content for mobile phones, he doesn't believe it will be profitable any time soon. "None of that is being broadcast in the U.S. and it's only softcore right now — naked girls dancing," he says. "The big carriers here aren't willing to broadcast that kind of content."