The merger of enterprises will go further next year, the report said.

The white paper, on the air conditioner retail market in key cities this year, shows that the sales volume decreased by 7.24 per cent, and sales revenue declined by 1.98 per cent. This is the first time the sales of air conditioners dropped since monitoring began in 1991.

Cai Ying, head of SIC's marketing information division, said Chinese air-conditioner manufacturers experienced unprecedented difficulties this year. The market has almost come to saturation, with the sales of air conditioners declining by 64 per cent in first-tier cities, and the consumption potential of the third- and fourth-tier markets has not been fully realized, she said.

The international anti-dumping tide, Cai added, as well as the implementation of the European Union's WEEE (Waste Electrical and Electronic Equipment) Directive and the RoHS (Restrictions on the Use of Certain Hazardous Substances) Directive has had a negative influence on exported air conditioner.

Apart from the decline of the domestic and international markets, the rise of energy and raw materials prices increased the cost of manufacturing and further narrowed the profit margin. The price of copper, for instance, has risen from less than 30,000 yuan (US$3,750) per ton at the end of 2005 to more than 80,000 yuan (US$10,000). That, in turn, has increased the cost of each air conditioner, which on average needs 6 kilograms of copper, by 200 yuan (US$25) to 300 yuan (US$37.50).

Cai said the decline of retail markets in the largest cities, however, is only one of the many difficulties manufacturers face. The greater threat lies in the increase in loans and use of too much storage space caused by the deteriorated market.

"That has caused trouble in the cash flow of many enterprises," Cai said. "These problems have directly influenced the security of the whole air conditioning industry."

The fast expansion of air conditioner industry in recent several decades is the cause of the current problem. "The domestic air conditioning industry needs to establish a new competitive attitude," said Lu Shenghua of the China Home Electrical Appliance Association. What's more, the demand for air conditioners will continue to be low in the next few years, he added.

The market decline and fierce competition have forced many brands to recede from the market. The white paper said 52 brands are being monitored by the State Information Centre this year, compared with 69 in 2005.

The top 20 brands account for 97 per cent of the sales. "The number of air conditioner brands will stay at 15 to 20 in 2007," Cai said. "The merger of enterprises and the integration of resources will go further."

Despite the overall downturn, the demand for products using advanced technology that perform multiple functions keeps increasing. The latest SIC data show that the sales volume of higher-end air conditioners increased by 47 per cent, whereas that of air conditioners priced below 1,500 yuan (US$187.50) declined by 46 per cent.

The major manufacturers have sensed the trend and started to shift their focus to technological innovation and the development of multifunctional products. Haier, the leading air-conditioner manufacturer in China, recently announced that next year it would start to manufacture new products that emphasize on air cleaning and humidity enhancing functions besides its cooling and heating functions.