Given the rapidly developing consumer economy in China, it is hardly surprising that the premium spirits sector has been such a growth area. What is rather more surprising is that, in contrast to many developing markets, China's domestic spirit, baijiu, more than holds its own at the pinnacle of the spirits pyramid, in spite of the cachet of international brands.

In fact, a recently-published report from The IWSR asserts that "the widespread impression among Western companies that the Chinese consider foreign spirits as being of superior quality to their home produce is completely untrue: baijiu is by a distance the largest super/ultra-premium/prestige spirits category in China."

According to The IWSR Baijiu Report, in contrast to most other developing countries with a large domestic spirits production, baijiu is not always synonymous with low price. Moreover, the ultra-premium/prestige baijiu category has been growing faster than the standard/low-priced sector over the past five years.

Sales of ultra-premium/prestige baijiu are dependent on consumption and gifting by Chinese government officials, so much so that any government directive asking for restraint in public expenditure affects ultra-premium/prestige baijiu sales and prices. The report estimates that as much as 30% of super-premium baijiu is purchased directly by the Government for distribution among Communist Party members.

Interestingly, however, baijiu is rarely consumed in bars, nightclubs or ‘KTV’ karaoke lounges. In contrast, baijiu is drunk with meals and banquets. Indeed, the report suggests that this may be a consumption occasion which represents a considerable opportunity for Western-style spirits, as only wine and Cognac have made any inroads in this area and, even then, in only two provinces.

So, on the face of it, baijiu, which is a clear, a grain-based distilled spirit, typically at 40% to 60% abv, should be an interesting investment opportunity for international spirits companies. However, the report warns that the conventional advantage of gaining distribution clout and a route-to-market for imported products from such an acquisition does not exist in China.

Not only does the product have little or no presence in the modern on-trade outlet (MOT) sector, The IWSR points out that the distribution channels for baijiu and Western-style or imported spirits are different. "Any Western company hoping to gain distribution muscle for its Western-style spirits portfolio in the short term by acquiring (in whole or in part) a baijiu company, will be disappointed," the report states.

There are, however, "less tangible" benefits. "The advantage of buying a share in a baijiu company will be less tangible and more long-term: to better understand how the Chinese consumer’s mind works and how distribution channels work."

Such insight may alone justify the investment, but gaining full control of a baijiu brand is not possible for foreign companies. The government protects baijiu companies for heritage reasons. Only joint ventures with foreign groups are allowed, while the top baijiu companies are not permitted to accept foreign capital.

For this reason, foreign investment in baijiu companies has been very limited.

Diageo was the first international drinks group to buy into a baijiu producer and, not surprisingly, chose a brand with strong premium credentials. While Shui Jing Fang is far from being one of the largest producers by volume and ranks just inside the top 20 by value - if only the ultra-premium-plus baijiu segment is considered -Shui Jing Fang would be among the top five. The other international groups with an interest in the sector are Pernod Ricard, LVMH and ThaiBev.

In terms of scale, the baijiu sector is, by any reckoning, impressive. If all baijiu produced in 2010 was consumed, it would represent over one-third of all traceable spirits consumption on the planet. Production has almost doubled over the last five years to reach its current base of almost 1bn cases.

Baijiu is drunk at almost all occasions in China where alcoholic beverages are consumed, from daily residential consumption to family or business gatherings, while the primary gifting occasions are the Chinese New Year and Mid-Autumn Festival. Brand marketing is focused on heritage, age and provenance with packaging generally finished in red and gold, colours which have positive connotations in Chinese culture. More expensive variants come in oversized external packaging with a relatively small bottle.

However, while baijiu may have a presence in the premium spirits market not enjoyed by national spirits in some other developing markets, it faces a challenge not unfamilar to traditional spirits.

The IWSR report points to baijiu's ageing consumer base and the lack of affinity with younger consumers, with whom Western-style spirits carry much more appeal.

"Baijiu’s popularity, coupled with the scale of China’s consumerism, gives the industry colossal momentum, which could take decades to slow," the report states. "However, when you consider that most baijiu consumers are male and aged 30-plus, and the fact that the culture of baijiu is not being readily adopted by the new 18- to 25-year-old generation of drinkers, it appears that baijiu may yet face a significant decline in the years to come."

This may necessitate some radical new thinking on the part of established brands that rely more on their cultural position in the marketplace than on the type of innovation characterised by Western-style and imported spirits. As the report concludes: "In the long term, traditional brands are going to have to do something quite drastic to maintain their market dominance."