The Chinese dairy industry is in transition from a traditional centrally planned to a more market-oriented sector. This paper reviews the development process of dairy industry and the characteristics of different types of dairy farms existing in China. A range of factors affecting the development of dairy farming in China are analysed, which include small scale, poor management, lack of appropriate technology and effective training of dairy farmers, lack of extension and marketing services, lack of marketing incentives due to the traditional consumption pattern etc. The present situation of dairy products consumption and challenges under the market-oriented economy are also discussed. Finally the realistic alternatives in reconstructing dairy industry and relevant policies are recommended.