Companies that produce baby formula will be required to have their own dairy farms, according to measures released by nine ministries on Thursday.
The move is designed to allow greater supervision of the production process, help ensure food safety and restore consumer confidence in the industry, officials said.
Other measures include adopting stricter management standards to supervise the baby formula industry and registering all foreign producers.
The measures were drafted by central government departments including the China Food and Drug Administration and the Ministry of Industry and Information Technology.
"A quality gap in the source of dairy does exist between Chinese and foreign baby formula products," said Teng Jiacai, deputy head of the China Food and Drug Administration, "though ours could match foreign counterparts in formula design and production technology".
Chen Junshi, a member of the Chinese Academy of Engineering at the China National Center for Food Safety Risk Assessment, said: "It would be very difficult to ensure the quality and safety of a company's source of milk if it does not have its own farms".
Industry insiders blamed milk sources as the major reason behind a major dairy scandal in 2008, when excessive melamine was added to milk to make protein content appear higher. At least 300,000 babies were sickened and six died.
According to Wang Dingmian, executive council member of the Dairy Association of China, most milk sheds - which act as middlemen between dairy farmers and producers - operated under almost no supervision before 2008, resulting in quality risks.
In response, agricultural authorities have intensified supervision of dairy sources, and the number of certified milk sheds has decreased 34 percent to 13,000, said Wang Feng, an official at the Ministry of Agriculture's animal husbandry department.
Large dairy farms are also expanding, and the number of farms with more than 100 cows accounted for 35 percent of those, an increase of 15.5 percentage points over 2008.
Several major dairy enterprises in China have gradually stopped buying milk from individual farms or milk sheds, and have turned to their own farms, Chen said.
"But safety risks still exist for some small dairy producers that rely on milk sheds for milk sources," he said.
Chen Fuquan, vice-president of Yili Industrial Group, one of China's largest dairy producers, said the company had invested about 9 billion yuan ($147 million) by the end of last year to build cow farms, which ensure stable and high-quality sources.
Another major dairy producer, Yashili International Holdings, will open a new factory in Waikato, New Zealand, with an investment of 1.1 billion yuan, to produce infant formula.
Lin Jinlin, spokesman for Yashili International Holdings Ltd, said quality dairy sources are important.
On Tuesday, China Mengniu Dairy, the country's largest dairy producer, acquired more than 75 percent of Yashili.
Industry analysts expect more mergers in the industry.
Gao Fu, an official with the Ministry of Industry and Information Technology, said such integration would enhance industrial resources, consolidate brands and improve competitiveness.
The ministry has pushed domestic dairy producers to "get married". Gao hopes to see about 10 companies, with annual revenues exceeding 2 billion yuan in two years, taking up 70 percent of the industry.
"Out of about 120 baby formula producers in China, only 15 percent have their own cow farms," said Wang Dingmian. "Many of these enterprises that don't have financial capabilities to run cow farms may have to quit."
It takes time to restore consumer confidence in domestic milk powder as many consumers have turned to foreign producers, Wang Dingmian said.
According to him, public confidence in domestic dairy products hit a low after the 2008 incident, resulting in soaring sales of foreign brand milk, which has accounted for 85 percent of the market in some major cities.
However, a number of low quality foreign formula milk brands also entered the Chinese market, according to Xiang Jianjun, a researcher with CIConsulting, a leading industry research institution.
The General Administration of Quality Supervision, Inspection and Quarantine said on Thursday it would take stricter measures, such as requiring all overseas dairy producers to register in China before they can export to the country, and banning companies from outsourcing baby formula production.
Imported baby formula must arrive in packages for retail to avoid repackaging and redistribution, during which imported goods are sometimes adulterated.