China's LED industry is facing a drastic shake-up caused by failing firms and price drops, said a report released Thursday.

The average price of Chinese LED chips declined 32 percent year-on-year in 2012, according to a report issued by industry service provider Gaogong LED Industry Research Center.

The government has encouraged the use of LED lighting to reduce emissions, triggering intense competition among small LED firms.

From 2009 to 2011, the number of new LED chip companies hit a record high of more than 80. But 20 of them went out of business in 2012, the report showed.