Almost all domestic handset makers that reported interim earnings in the past two weeks - such as foreign rivals Motorola and Nokia - have seen profit margins fall. This, however, has been at a faster pace than their competitors.

For example, Nanjing Panda Electronics, which partners Swedish rival Ericsson to make mobile handsets in China, saw its profit margin fall nearly 40 per cent in the second quarter because of its aggressive marketing efforts to gain market share.

Ningbo Bird saw its profit margin drop to 16.52 per cent compared with 24.55 per cent last year. TCL Mobile Communications' profit margin fell from 26 per cent last year to 20 per cent this year.

The Ministry of Information Industry (MII) has warned local phone makers that their profits will be squeezed in the coming second half, posing a survival risk if they fail to add value to their products.

In a first-half review of the top-100 Chinese electronics and IT products manufacturers' earnings performance, the MII said traditional consumer electronic goods, especially mobile handsets, had an even tougher challenge ahead.

'Competition in the domestic market is getting tougher and tougher ... due to a slowing down in the pace of growth in the domestic market, the imbalance between demand and supply will become more obvious,' said the telecommunications regulator in a review on its website.

China's handset sector has been facing an oversupply problem in the past quarter as almost all major phone makers aggressively expanded output, hoping to increase share in the world's biggest and fastest-growing mobile market.

According to the MII's earlier release, domestic handset brands captured 55.28 per cent market share in the first half, a substantial boost from 39.37 per cent for the same period last year.

But other industrial research firms challenged the MII's figures, saying they did not reflect the actual situation as they recorded data relating to the wholesale level and not end-users.

According to CCID Consulting, it estimates that about 20 million units of backlog handset stock are in warehouses and stores.

Beijing-based telecoms research firm MFC Insight estimated total annual production capacity in China had reached 200 million, while total handset consumption would hit about 70 million to 80 million, implying about 120 million to 130 million surplus units to be exported or stored as inventory.

The MII warned that since domestic and foreign handset makers were expanding investment in China, prices would continue to fall and profit margins trimmed.

'Those manufacturers which put brand tags on [imported] models may soon lose their ability to survive. For enterprises that accumulated certain product development capabilities, they must further improve their ability to add value ... to gain profit,' the telecoms regulator said.