Beijing can afford to change rules for Diageo

November 9, 2010

Scotland has scotch and China has white liquor. Baijiu, a clear drink with 50 percent alcohol, is China’s national pride. The sector has been largely off limits to foreign investors, but Diageo wants to pop it open with a $1.1 billion bid for producer Shui Jing Fang. China can show openness by letting the UK distiller in, and pick up some useful skills along the way.

What Diageo covets is access to a large and uniquely Chinese market. Top-end baijiu retails for as much $200 a bottle, and sales of white spirits are growing at over 10 percent a year, according to Euromonitor. Shui Jing Fang, in which Diageo currently owns 40 percent, has a 30 percent operating margin. That’s on par with Diageo’s and higher than Pernod Ricard’s.

Regulators seem to have other ideas. Top liquor brands are on the list of industries in which foreign investment is restricted. True, Shui Jing Fang does not technically appear on the twenty-year-old list of such protected brands, even though it is now China’s number four. But the deal has been stuck with the regulator since March.

Defending baijiu may inflame fears of global protectionism. Business leaders are super-sensitive about blocks on acquiring strategic assets after Canada blocked BHP’s bid for Potash Corp. China set a precedent when it stopped Coca Cola buying juice maker Huiyuan in 2009. British politicians have already waded in, with the British Business Secretary, Vince Cable, pledging to support the distiller’s case on his current trip to China.

China can afford to change the rules. Approving the deal would send a positive message about openness, which may win China friends at a time when it is under attack for its trade imbalances. Diageo may be able to help foreigners develop more of a taste for baijiu. Besides, as China buys up resources such as gas and oil in other countries, protecting far less scarce liquids is hard to justify.

Chinese liquor makers may even learn some new skills from Diageo, which specialises in high-end brands. Luxury is an area in which Western firms still have a distinct advantage. If China wants baijiu to one day be the new scotch, it should raise a glass to open markets.

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