The company said that it has agreed to purchase a 50 per cent stake in a newly formed venture with distiller Nolet for $900m, in order to market and distribute the Ketel One vodka brand globally.
Until now, Diageo had been one of the main players expected to enter the bidding for Swedish group V&S, which makes the Absolut brand.
However, a Diageo spokesperson told BeverageDaily.com that the company would not be taking part in the auction for Absolut, despite its long-stated intentions to expand further into vodka production.
"In recent months we have gone through an internal process to review our strategy," the spokesperson stated. "
In the end, we concluded that Ketel One represented a much better strategic fit for Diageo.
A unique alliance Despite already owning the Smirnoff label, Diageo chief executive Paul Walsh said the Nolet agreement was a unique alliance within the spirits industry and strategically important for the group's growth aims.
"[The transaction] gives us an interest in an outstanding high quality brand and fantastic potential for global growth in the super-premium vodka segment," he stated.
The deal is expected to be completed by 31 March this year.
As part of the agreement, the Nolet distillery, where Ketel One is manufactured, will remain in control of the founding company along with the brand itself.
However, Ketel One will be exclusively supplied to the Diageo joint venture at an agreed rate.
Under these same terms, should either party then wish to sell its stake in the joint venture, the other group will then be giving first right to purchase the remaining shares at a yet-to-be agreed price.
Should Diageo acquire the Nolet Family's stake, then the group would then claim full ownership of the brand.
Premium vodka market A growing number of manufacturers have moved to expand into the premium vodka segment over the last year on the back of strong growth in the segment.
Global vodka sales were estimated to amount to $48.5bn in 2006, according to market analyst Euromonitor.
By 2012, global sales volumes for Vodka are set to rise by 7.3 per cent from 2002, Euromonitor added.
However, this growth is expected to undergo a slowdown between 2007 and 2012, attributing top just 1.4 percentage points worth of the total growth over the ten year period.
Over the same five-year period, growth within the total spirits market is expected to increase by about 10.8 per cent according to the analyst's figures.
Changing consumer appeal In analysing the market, Euromonitor therefore urged caution over the drive to enter the premium vodka market, which it claimed was "notoriously fickle ."
"The recent admission that if you remove the advertising, there is very little premium content in any vodka makes that super premium image very fragile," the analyst said.