Country Analysis Report Of The People's Republic of China

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Introduction

Diageo PLC (NYSE DEO), formed by the 17 merger between alcoholic beverage giant Guinness with food and spirits company Grand Metropolitan, is the world's largest producer of alcoholic drinks. Its beers and distilled spirits include Smirnoff, Johnnie Walker, Guinness, Baileys, J&B, Captain Morgan, Cuervo, Tanqueray, and Beaulieu Vineyard and Sterling Vineyards wines. Diageo helps stock bars and shelves in over 00 countries around the globe. After earning enormous profits from its major markets in North America, Great Britain, Ireland, and Spain, the company is planning to enter the alcoholic beverages market in the People's Republic of China with its popular flavored malt beverages.

Like beer, flavored malt beverages such as Smirnoff Ice and Captain Morgan Gold are created in breweries using water, yeast, fermented malted barley and hops, but unlike beer, they are then flavored with citrus, vodka and other highly concentrated ingredients.

This country analysis report will assess the investment potential for Diageo's expansions of production facilities and sales in China. Various factors including economic, political, infrastructural, ethical, and cultural conditions in China will be evaluated in detail, as well as Chinese market potential for flavored malt beverages (Harmonized System Number 0.00.0000), and this report will wrap up with a recommendation on the steps that should be taken for Diageo.

Economics Environment

Over the past half-century, China has experienced a dramatic change; an underdeveloped nation transformed into one of the world's fastest growing economies. Since the beginning of the open-door?policy in 178 and the accession to the World Trade Organization (WTO) in 001, China's economy has grown swiftly from a low base, and developed wide consumer market.

China has the biggest population in the world at 1. billion people. 0% of the population lives in the urban areas, while the remaining 70% is concentrated in the countryside. China is also the world's third largest country by area, covering .6 million square kilometers. Despite a GDP of USD 1.4 trillion, China is still one of the poorest countries due to the huge population spread. Rural per capita GDP is only USD 8.66 and urban per capita GDP is about USD 06.8. Labor cost per worker in manufacturing is approximately $800 per year with $,885 value added per worker in manufacturing.

China has the world's largest market size and growth rate. Diageo PLC will be able to find a huge market demand and a cheap labor supply in China. However, the low GDP per capita indicates that not every Chinese consumer can afford Diageo's products because their income is below the World Bank's USD 1 per day standard for absolute poverty.

Market and Industry

American companies continue to have mixed experiences in China. Some have been extremely profitable, while others have struggled. To be successful in China, Diageo PLC must thoroughly investigate the Chinese market for its flavored malt beverages.

The alcoholic drinks production market in China is diverse and extremely fragmented. Market size and potential vary from region, and nationally recognized brands are rare. There are currently about 40,000 distillers in China, all with varying degrees of production capabilities and national distribution. Miller Brewing, Anheuser-Busch, Allied Domecg, Bacardi, and Fortune brands have all established in China and experienced volume sales rather than margin growth.

Chinese are near the top consumers in Asia, and consume annually about 1 liters of spirits per capita; therefore, the growth of importing spirits is expected to continue. Until the large price differences are reduced, imports will have difficulty displacing domestic competition.

As compared to spirits, beer is a more popular drink in China. However, the younger Chinese generation prefer the lighter and better tasting beverage over beer from the influence of the globalization of Western culture.

China will be a big market for Diageo with its increasing demand for foreign alcoholic drinks. However, with all the domestic and foreign competitions in Chinese alcoholic drinks production market, and the majority of Chinese favoring beer, Diageo may want to market its drinks differently from other competitors, and focus on the younger generation segment such as college and white-collar workers in urban areas.

Business Climate

Before China's accession to the WTO, China prohibited foreign companies from distributing imported products. Since WTO implementation, China has worked towards liberalizing its distribution system to provide rights for U.S. firms. The U.S. Commercial Service and the International Partner Search will assist new-to-market firms like Diageo to locate, screen, and assess potential qualified overseas sales representatives, agents, distributors, joint venture partners, and licensees for the products.

Representative offices are the easiest type of offices for foreign firms to set up in

China, but Chinese law to performing liaison?activities limits these offices. Therefore, they cannot sign sales contracts or directly bill customers. A locally incorporated equity or cooperative joint venture with one or more Chinese partners and a wholly foreign-owned enterprise are also other alternatives to develop markets for a company's products. With careful selection, training, and constant contact, a U.S. company can obtain good market representation from a Chinese trading company. However, most of these trading companies cannot provide diversified coverage throughout China due to transportation and communication difficulties.

If Diageo decides to open its market in China, It will have to choose an entry mode for the company in China first. A joint venture is maybe the best choice for a big brewing company like Diageo. A good Chinese partner will have the connections to help smooth over red tap and obstructive bureaucrats, and in-country production avoids import restrictions including relatively high tariffs and unreasonable restrictions. Diageo will also have greater controls over both intellectual property and marketing, however, it should bear in mind that joint venture is time-consuming and resource demanding.

Political Environment

Although there has been considerable reform of China's economic model, the same is far less true of Chinese political system. The Chinese Communist Party still dominates the entire political apparatus, and its leaders make all major policy decisions. China faces a growing disconnection between the demands of its reforming economy and a political system that is largely ill suited to meet their needs.

Chinas new president and party leader, Hu Jintao, is most likely to focus on improving democracy within the party, such as giving party branches greater choice in the selection of their bosses. However, Mr. Hu would have to be sure to obtain support from Jiang Zemin, his predecessor, who is still in charge of the armed forces.

China has traditionally restricted imports through high tariffs and taxes, non-tariff measures, trading rights restriction, and other barriers. Chinese officials are increasingly aware that such protective measures contribute to endemic economic inefficiencies and encourage smuggling. To address these problems, the Chinese government agreed to dramatically reduce many barriers as part of it WTO accession. China also has reformed its tax system to minimize distinctions between domestic and foreign entities according to the principle of national treatment. In addition, China has substantially reduced the number of goods subject to import quotas and as part of its WTO commitments will continue to phase out or notify to the WTO all remaining quotas.

On top of normal tariff duties, both foreign and domestic enterprises are required to pay value-added taxes (VAT) and business taxes. VAT is assessed after the tariff, and incorporates the value of the tariff. China is now bound by WTO rules to offer identical tax treatment for domestic and imported products.

All products sold in China must be marked in the Chinese language with the relevant information. According to the Food Labeling Standards of China, imported foods shall have clear markings that indicate the country of origin in addition to the name and address of the general distributor that is registered in the country.

It will be better off for Diageo to establish factories in China instead of importing into China so that it can avoid various restrictions, tariffs, and taxes. In addition, it will be much easier to label its products in Chinese.

Country Risks

China is a country with great risk for importers, exporters, and investors. The outbreak of the Severe Acute Respiratory Syndrome (SARS) virus had negative economic effects on most industries in China, especially the service industry. The Chinese government is very concerned about the price depletion and growing unemployment caused by the SARS outbreak. Another concern is the growing disparity between urban and rural incomes because there are huge income gaps between the wealthy coastal regions and the poor interior regions. The central government of China acknowledges that unemployment and income inequality are growing problems and chief potential threats to stability in China.

China's political relations with the U.S. temporarily deteriorated following the accidental bombing of the Chinese Embassy in Belgrade, Yugoslavia, in May 1 and the collision of a U.S. EP- reconnaissance aircraft and a Chinese fighter in international airspace in April 001. Bilateral relations have gradually recovered from both incidents. China came out firmly in support of the United States following the September 11 terrorist attacks. Relations further improved with the October 001 and February 00 visits by President Bush to China and the October 00 visit of then President Jiang Zemin to the United States. However, differences remain between the U.S. and Chinese governments on some political issues such as non-proliferation, human rights, and rules over Tibet. All these issues will continue to color the relationship between the two countries.

Diageo needs to be tactful and knowledgeable of current political developments and risks involved. As Chinese service and entertainment industries continue on a downward spiral after the SARS crisis, demand for products related to these industries such as drinks and alcohol will decrease. There will also be the possibility of people in China banning U.S. goods if China and U.S. relation become worse.

Currency Issues

China has effectively pegged the exchange rate for its currency at RMB 8. to USD 1.00 since 17. With the fall in interest rates overseas, particularly the United States, China still maintained a good position in its balance of payments. Although some foreign observers believe that RMB is under-valued versus the U.S. dollar, the Chinese authorities have clearly indicated their belief that preserving stability in the exchange rate with the dollar serves China's interests. Depreciation of the RMB will decrease the average family's disposable income, meaning less and less people will be able to afford foreign goods. However, Diageo will be able to decrease its cost of doing business in China because U.S. dollar is valued more after RMB deprecates. Same amount of U.S. dollar will allow Diageo to purchase more goods in China.

In general, Chinese companies are not permitted to retain foreign exchange. In business deals with Chinese companies, U.S. companies have been asked to keep a portion of the Chinese companies?hard currency earnings in foreign bank accounts to avoid reporting and turning it over to the foreign exchange control authorities. In 17, China issued a new rule allowing some Chinese enterprises that meet a certain criteria to establish a foreign currency account in a designated bank, thus retaining a limited amount of foreign currency earnings. The banking sector is one area that has benefited from WTO accession. Client restriction on foreign banks?foreign currency services was one of the areas immediately removed upon China's WTO accession, which meant foreign banks could offer foreign currency services to corporate and individual clients.

Ethics Environment

Corruption remains widespread in China. Although the government launched a high profile anti-corruption campaign, these efforts are hampered by the lack of truly independent investigative bodies. Numerous senior provincial and municipal officials came under scrutiny, but there are widespread reports that many senior officials and their family members used their connections to avoid prosecution. Banking and finance are among the sectors most afflicted by corruption, as are government procurements and construction projects. China's business practices commonly involve grease payments?which may be in violation of U.S. Foreign Corrupt Practices Act.

For Diageo, it will be important to maintain goodwill with business associates while obeying both Chinese and U.S. laws. Diageo will have to make good judgment on what firms and banks to deal with, and which to stay away from. Any wrong move could lead to potential dangers in the future.

Infrastructure Analysis

Although developing at an impressive rate, China generally has very poor infrastructure. It is stricken with power shortages, weak transportation, and relies on the support of billions of dollars provided by foreigners. Recently, infrastructure investment has been a key element of China's economic growth potential with major infusions scheduled for the road, railway, port, telecommunications, oil and gas, and coal sectors. Since 18, the Chinese government has issued about RMB 70 billion in special bonds to fund infrastructure projects aimed at stimulating the domestic economy.

Telecommunications

Infrastructure development in the telecommunications sector remains strong and China now boasts the largest wireless networks in the world. The Chinese government has made telecommunications and IT development a national priority and enacted preferential policy initiatives to promote telecommunications modernization throughout the country. Computer and Internet connections are also becoming more and more popular and affordable in China.

With the increasing rise of technology and development of the telecommunications system, Diageo should not have to worry about communicating employees in overseas company via internet and phone communications.

Transportations

China's inadequate transport system constitutes a serious obstacle to future economic growth, with virtually every facet of it already run to capacity. The backbone of the system remains the railway. New railways recently constructed include a ,81 kilometers north-south link bisecting the existing coastal routes. The road network has also failed to keep pace with a rapid increase in the number of automobiles on the roads. Similar problems affect ports, of which Shanghai remains the most important, accounting for 0.7% of sea cargo handled. Despite the difficulties of distributing nationally in China, which stem largely from the country's poor transportation infrastructure, the large volume sales and relatively low retail prices in China have encourage investors to set up regional plants.

Diageo should take into strong consideration about the relatively poor transportation systems in China. A company such as Diageo needs a strong transportation system to be able to ship its products across different parts of the country. Without a properly fitted system, delays and problems will certainly affect business for the company.

Human Resources

China had made considerable strides in reducing the number of illiterate people. In 000, illiteracy had decreased from 14% in 10 to 8% for males and % to 1% for females. The youth illiteracy rate is even lower % to 1% for males and 8% to 4% for females. Many rural schools are inadequately funded despite a notional nine years of compulsory education, and very small percentage of people attends college and higher education institutions.

China will continue to suffer in the future from an acute shortage of skilled personnel. Diageo will easily find workers in China that are suited for its labor-intensive beverage production; however, it might become a big problem for the company to find highly skilled management personnel to run the subsidiary in China.

Location

China is a collection of large and distinctly different regional markets. Studies have identified six regional markets each with a population of over 100 million and a GDP exceeding USD 0 billion

?Northeast ?Heilongjiang, Jilin, and Liaoning

?Greater Beijing ?Beijing, Tianjin, Hebei, and Shandong

?Central Provinces ?Shaanxi, Henan, Hubei, Anhui, Jiangxi, Sichuan, and Chongqing

?Greater Shanghai ?Shanghai, Jiangsu, and Zhejiang

?Greater Guangdong ?Guangdong, Fujian, Hainan, and Hong Kong

China's central inland region is less developed and the west region is the least developed. Most of China's economic and commercial activities are concentrated on the coastal regions such as Greater Beijing, Greater Shanghai, and Greater Guangdong.

Shanghai, the core of the Yangtze Delta Region, would be the ideal location for Diageo. There are more than 180 million consumers in this region over an area approximately the size of Great Britain. Shanghai is the natural focal point of all the potential wealth on the Yangtze River basin. As communication, power and transportation keep developing in the basin, the Shanghai area will soon surpass the regional wealth of South China. With regard to distribution, Shanghai has a quite decent developed system. The Chinese government in this area has encouraged retailing, and the number of supermarkets rises systematically. Shanghai also offers special investment zones offering a variety of incentives for foreign investors, the most famous example being the Pudong area in Shanghai. Furthermore, Shanghai consumers are traditionally reckoned as people open to foreign influences and fond of international brands, this fact together with their relatively high incomes have proven to be good reasons for Diageo to locate and invest in Shanghai.

Culture Analysis

Hofstede Scale indicated that China has many different workplace values compared to the United States. China rates high on long-term orientation/Confucian dynamism (118), and power distance (80), moderate on assertiveness (50), and getting low scores on uncertainty avoidance (8), and individualism (10). In general, the Chinese are focused on the future, value dedication, hard work, thrift, perseverance, and saving for the long-term. The average Chinese worker will concentrate on fitting in with the group and maintaining well defined social networks and boundaries.

Regional Customs

There are many different provinces, dialects and regional cultures throughout China. Diageo will need to segment the market and understand the differences among the different regions. Since it is recommended that Diageo put forth most of its marketing efforts to Shanghai consumers, Diageo managers must understand how Chinese urban mentality and its traditions interface when dealing with both marketing and employee situations.

Consumers

Chinese consumers are pragmatic, price and quality conscious and careful planners. Most Chinese consumers are sensitive to price and will usually choose the less expensive product unless they can be swayed by better after-sales service or clearly better product quality. While they clearly prefer imported, high-quality products, they do not blindly buy Western. China's consumer preferences tend to differ according to geographic location, as regions vary in their levels of economic development. As a matter of fact, there are also significant differences in purchasing power and attitudes between rural and urban residents. A number of Chinese consumers can afford foreign-made appliances, food and other goods. Diageo needs to bear in mind that 70% of all Chinese live in rural area, and they look for quality at a good price.

Relationships

Personal relationships (guanxi?in Chinese) in business are critical. The Chinese feel more comfortable dealing with old friends? and it is important for exporters, importers, and investors to establish and maintain close relationships with their Chinese counterparts and relevant government agencies. It is equally important that American exporters encourage strong personal relationships between their Chinese partners, agents or distributors and the buyers and end-users. A web of strong personal relationships will help ensure smoother development of business in China.

Recommendation

Before arriving at a recommendation, it is important to summarize the anticipated advantages and disadvantages Diageo will face in China

ProsCons

Largest market sizePoor consuming power

Cheap labor supplyStiff competition

Stable currencySlim profit margins

WTO accessionHigh country risks

Potential market in ShanghaiUnstable relation with U.S.

High long-term orientation dynamismWidespread corruption

Poor infrastructure

Lack of highly skilled workers

It is not recommended that Diageo enter the Chinese beverage market at this time. Competition in this industry is intense, profits are slim, and there are great risks doing business in China. However, Diageo should not forgo such a large market either, the company should observe the economic, political, and culture environments in China closely for a longer period of time. If China continues improving its market under WTO's influences, then Diageo can enter with more confidence.

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