What is Industry Classification?

by Jonathan Ringvald in

What is Industry Classification?

Industry classification is a method used to categorize business types into groups based on characteristics and common operations. For example, a business whose operations are primarily characterized by cutting hair might be categorized under "Barber Shop" or even "Beauty Salon".

There are several different industry classification systems used by different industries and different countries around the world.

The most common classification systems in the North America are NAICS, North American Industry Classification System (pronounced like snakes 🐍🐍) and SIC, Standard Industrial Classification. Both systems are valid and both have their pitfalls, which will be described in another blog post.

Read more about the definition of Industry Classification here: https://en.wikipedia.org/wiki/Industry_classification

Why is Industry Classification Important?

Industry classification is important to many industries, businesses and government organizations.

Governments use industry classification to track business and labor trends, design programs, and determine tax schemes.

Financial companies use industry classifications to price risk and choose which clients to underwrite.

Marketing and sales departments use industry classifications to appropriately label businesses and tailor messaging to the right customers or target sales in the right direction.

How to classify a business?

NAICS was developed to capture and express the essence of how a business delivers value to the economy and should reflect the operations within the business that primarily generate revenue for that business.

For example, if a business makes most of it's revenue charging customers for hair cuts, they're most likely a barber shop (812111).

One key pitfall to avoid while classifying a business is understanding the difference between Manufacturing and Retailing. For example, it might be tempting to classify a store that sells furniture as a furniture store (442110), while they might actually be a furniture manufacturer (337122). Making this mistake might seem harmless and understandable. But the operations that go on inside of a furniture manufacturer are far different than that of a furniture store.

Another pitfall, especially in recent years with new apps being developed everyday is the difference between the benefits that a company offers vs. its actual operations. One example that comes to mind is Amazon's Kindle which offers digital books. On the surface one might categorize it as a book store, but on closer look they are an electronic store (443142) or more likely a custom programming solution provider (541511).

The problems with NAICS (and other IC systems)

NAICS doesn't update often enough

NAICS, for example is updated every 5 years. The next update is coming in 2022. This leads to gaps in coverage of codes caused by new industries popping up.

The speed at which the economy is changing is accelerating every year as more businesses become digitally enabled, more people are finding ways to provide value in different ways. In this author's opinion, NAICS, or some equivalent, should renew every year.

Notable NAICS gaps include:

E-commerce stores (454110)

E-commerce stores have been haphazardly thrown into a bucket with several irrelevant sub-industries such as "online catalogs" and "mail-order houses". As this industry continues to skyrocket in growth, especially after covid, it deserves it's own coding.

Marijuana Dispensaries (453998)

These stores belong to a catch-all category called "All Other Miscellaneous Store Retailers (except Tobacco Stores)". Marijuana dispensaries have proven themselves to be their own type of business, especially in recent years as regulations have loosened in several US states.

What if a company has multiple revenue streams?

Industry Classification guidance suggests you put down only one "primary" code when classifying a business.

What if a business has more than one, or even several different income streams? This isn't just a theory. Several businesses, especially smaller and newly incorporated businesses are continuously finding their market, pivoting and adding more services as clients demand them. This behavior is especially prevalent in sectors like contracting and construction which we find are often misclassified.

Read more about the broken industry classification system.

If Industry Classification is broken, what's the solution?

The solution isn't that simple. At our company we've developed a world-class solution for industry classification. On top of that we've developed features like an algorithm that finds multiple potential industry classifications of a business, words and business keywords that describe a business if it falls outside of the taxonomy, and even confidence scores and relevant links. Check out our product page to learn more.

At Relativity6, we're obsessed with the industry classification problem and Artificial Intelligence. And more so, we're obsessed with solving the industry classification problem with AI. To that end, we've developed an algorithm that delivers 80%+ accuracy when classifying businesses across the globe via API with responses in under 1 second. All you input is a business's name and address.

Every day we iterate on our algorithms, feed them more data, and find techniques and strategies to get more accurate.

Check out the video below to see the Relativity6 Industry Classification API in action:

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