I'm probably biased, because I work for SitePoint (which owns 99designs -- though I have nothing to do with that part of the operation), but have also previously owned a design contest site (GFXcontests.com). I'm not so sure it is bad for the design industry.

Reasons why it's good:

1. It provides portfolio building opportunities and real-world client experience for new designers

2. It provides hobbyists a good way to try their hand at professional work

3. If the contest holder (client) holds up their end of the bargain and provides all entries with quality feedback, it provides useful practice for designers.

4. I've heard from a large number of designers that participating in design contests led to more visibility for their portfolios and in turn helped them land regular, non-contest employees

5. I can say with confidence that a number of designers on 99designs at least are earning healthy five-figure incomes from contest work

6. Many designers are able to sell losing designs as templates (though contest holders should be careful to put in a stipulation that designers should only be allowed to do that once they remove your name/IP from the design)... or they can repurpose the designs for another contest or client

Why it might be bad:

1. The No-Spec people will say it takes paid opportunities away from designers (I might rebut that it gives more designers the opportunity to compete for work and make a name for themselves -- and that no top tier designer I know is struggling for work)

2. They'll also say that it is unfair for designers -- who are asked to create work with no guarantee that they'll be paid (the rebuttal here: if you don't want to work that way, don't participate -- and as I said above, losing designers can still often make some money from that effort)

Just my (perhaps biased) two cents.

Of course it isn't. But it's a lot more efficient. I have a hard time buying the concept of paying a designer $500 on a project basis, when I could pay $500 to the best of 30+ submissions I receive.