That’s one clear lesson from the sales rankings at the Apple Store, which posts a regularly updated list of the most popular iPod models. Though the iPod classic, which uses a hard drive to store music and video, offers a whopping 80 gigabytes of storage for $249, it is being outsold by the iPod touch. This, despite the fact that the touch has a tenth of the storage space and costs $50 more.

Why is the touch beating the classic? For one, the iPod touch has the benefit of good looks – it’s almost identical to the iPhone, this year’s must-have gadget. The touch also has a large display, built-in WiFi and web browsing. (The iPod touch is isn’t Apple’s best-selling model; number-one is the slim iPod nano, which starts at $149. It doesn’t use a hard drive either.)

The iPod sales trend is important as Apple (AAPL) today reports earnings for fiscal 2007. Apple’s iPod has been the product that most visibly fueled the company’s turnaround over the past few years, and it has allowed Apple to dominate the burgeoning digital music business. The iPod commands about 70 percent of the digital media player market, and Apple’s iTunes Music Store is the go-to place for media downloads.

But recently Apple is seeing increased competition. Rivals such as SanDisk (SNDK), Microsoft (MSFT) and Sony (SNE), which were slow to catch on to the iPod’s popularity, are introducing sleeker models. Apple also faces more credible rivals to its iTunes store. Amazon (AMZN) recently began selling MP3 downloads without copy protection that will play on any music player, including an iPod; Microsoft plans to launch a similar store next month.

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The iPod classic. Photo: Apple

So it’s especially noteworthy that mere storage capacity doesn’t seem to be the main factor driving iPod sales. This detail actually bodes well for Apple; the more it can position its device design and software interface as unique selling points, the harder it will be for competitors to dethrone the iPod.

Storage wasn’t always so passé. When the iPod first came out, Apple priced the models based on how much music they could hold. The entry-level iPod had a 5-gigabyte hard drive, and higher-capacity models were more expensive. It was generally understood in the marketplace that the higher-capacity iPods were more desirable.

That mindset began to change when Apple introduced the iPod nano. Rather than rely on a bulkier, higher-capacity hard drive, the nano used flash memory, a type of semiconductor that stores digital information. (Corrected from an earlier version. Readers remind me that the iPod mini was hard drive-based. Thanks, readers, as always.) Flash memory is smaller than a hard drive, and requires less power to run – but it also stores less data.

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For a long time, Apple didn’t seem to expect consumers to embrace flash-based players. On several occasions in the iPod’s early days, I pressed Apple worldwide product marketing chief about when the company might begin using flash storage for devices, as many of its competitors were. He typically responded that hard drives held far more music, and would do so for the foreseeable future, so there wasn’t much reason for Apple to embrace flash.

But when Apple offered the iPod nano, that mindset changed. The nano, became the bestselling iPod model, thanks to its slim, pocketable size and low price. Now the flash-based iPod touch is taking that trend to another level. Remarkably, even though the iPod touch costs more than iPods that hold more content, consumers appear to find it more desirable.

At least for now. Steve Baker, analyst for NPD Group, notes that the iPod touch has only been on sale for about a month, so it’s early to draw too many conclusions. Some of the iPod touch’s popularity might be due to its similarity to the popular iPhone. But still, demand for the touch makes sense, he said.

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“The base of users who need to upgrade their 30GB player to 160 GB drives is pretty small,” Baker said, referring to the highest-capacity hard drive-based iPod. Demand, he says, “has more to do with the touch being a different kind of product.”

Might it also have to do with the fact that downloadable video still isn’t easy to come by? While Apple has millions of songs available for purchase on iTunes, Hollywood studios have been less eager to offer their video libraries to Apple. Studio chiefs feel Apple demands too much control over how downloadable movies and TV shows are priced, and have complained that Apple’s main objective is to provide cheap content to drive iPod sales, not to create a healthy marketplace for content.

If Apple and the studios work out an agreement sometime soon, or if some other retailer begins selling iPod-friendly downloads, perhaps consumer tastes will shift back toward higher-capacity hard drive-based players.

But until then, big screens, Internet connectivity and advanced software seem to be more important selling points than raw storage capacity. And for Apple, that’s a good thing.

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