Nobody expected the number-one-with-a-bullet rise of the music videogame—least of all the music industry. Armed with little more than crappy graphics, plastic guitars, and epic hooks, play-along titles like Guitar Hero and Rock Band have become an industry in their own right, raking in more than $2.3 billion over the past three years. Album sales fell 19 percent this past holiday season, but the thrill isn’t gone—it just moved to a different platform.

The success of these games is good news for the music biz. They’re breathing new life into old bands (Weezer, anyone?) and helping popularize new ones. They’re even becoming a significant distribution outlet for new releases. So the record labels ought to be ecstatic, right? Nope. They’re whining over licensing fees.

“The amount being paid to the music industry, even though [these] games are entirely dependent on the content we own and control, is far too small,” Warner Music Group CEO Edgar Bronfman told analysts last summer. The money Warner receives for the use of its songs is “paltry,” he said, and if the gamemakers don’t pony up more cash, “we will not license to those games.” In response, Rock Band publisher MTV Games is now boycotting Warner artists, according to a source close to the negotiations.

This is a fight no one can win. Putting the brakes on music gaming would hurt everyone in the ailing music industry. Instead of demanding greater profit participation, Warner should be angling for creative participation. Thirty years ago, Hollywood took a similar threat—the VCR—and turned it into a new source of revenue, building customer loyalty in the process. The music industry could use new games the same way—but its track record suggests that it won’t.

How does this play out? Gamemakers could respond by using cover versions of songs from the Warner catalog, but Bronfman already has that move blocked. He also runs the giant music publisher Warner/Chappell, and he could deny the game companies access there, too. From Bronfman’s perspective, the record labels got ripped off when MTV was sold in 1985 for $690 million ($1.4 billion in today’s dollars) on the strength of videos it received for free, and then ripped off again when Apple initially denied the labels control over pricing on iTunes. He won’t get fooled again.

To be fair, Bronfman has a point. Game publishers generally sign low-cost synchronization licenses—as if the music were being used incidentally, in the background. Compare this to Electronic Arts’ Madden NFL franchise, from which the football league collects some 30 percent of gross revenue, and you can begin to feel his pain.

But there’s better money to be made by playing together. Music games are proven earners—Aerosmith has reportedly earned more from Guitar Hero : Aerosmith than from any single album in the band’s history. The labels ought to push for more such titles and integrate them into their promotional strategies. They might not maximize profit on the licensing, but who cares? With more entries to come in the play-along genre, and networked hardware to play them on, the games themselves could even become an online music retail channel to rival iTunes. Or what about a game for turntable artists? Labels could provide the stem tracks for songs (in which each instrument’s recording is isolated) and let players mix their own versions. Users could vote for their favorites through online services like Xbox Live, and Warner could sell the winning mixes back to customers using the very platform on which they were created. Call it Wii-Mix.

If the company wants a case study, it need look no further than Universal Music Group. Rather than cavil over licensing fees, Universal parent company Vivendi simply bought Guitar Hero’s publisher, Activision. Look, the labels know that recorded music is in irreversible decline. Warner has actually led the industry with a policy of signing bands to so-called 360 deals, in which artists give the label a cut of everything they sell, be it ringtones, merchandise, or concert tickets. On the strength of such foresight, Bronfman has styled himself as the man who will reinvent the music industry. But part of that reinvention must be an end to petty haggling over fees. Going PvP against gamemakers isn’t going to solve the industry’s problems. At this point, Bronfman still seems intent on dragging his business kicking and screaming back to the 20th century.