A spokesman has confirmed that nearly half of Chinese dairies inspected in a government safety audit have been ordered to stop production.
The move follows the 2008 baby milk health scandal, in which Chinese authorities said at least six babies died and another 300,000 were sickened.
China's dairy industry was rocked that year by revelations that the industrial chemical melamine was added to powdered milk to make it appear higher in protein content, causing worldwide recalls of products containing Chinese dairy.
Two people were executed for their roles in the scandal.
To restore consumer confidence in dairy products, the ministerial-level General Administration of Quality Supervision, Inspection and Quarantine decided to inspect all businesses in the industry.
Only 643 companies from a total of 1,176 had their licences renewed, while 426 failed the quality criteria set by the audit and 107 others had already stopped production to bring themselves into compliance, said administration spokesman Li Yuanping in comments reported on its website.
Of the 145 companies producing milk powder for babies, 114 had their licence renewed, he said.
The authorities will strengthen supervision of dairy companies, both those who passed the audit and the those who did not, and "production without authorisation will be severely punished", said Li.
The measures taken will lead to more than 20 percent of businesses being closed, the Dairy Producers Association of China predicted in an article in China Daily on Monday.
The newspaper stated that the closures would affect mainly small producers who account for about 10 percent of the market.
China detained nearly 100 people in January suspected of producing and selling melamine-tainted dairy products, despite a ban after the 2008 scandal.
The Food Safety Committee Office of the State Council, China's cabinet, said authorities had investigated 40 cases involving tainted milk and detained 96 suspects since July.
Authorities said at the time of the 2008 scandal that all suspect milk powder had been confiscated or destroyed and have promised to clean up the industry but reports of tainted products being discovered on the market have continued to emerge.
In July last year, authorities said they had found 25,000 tonnes of tainted milk powder earlier in the year.