Why Industry Classification is Broken

by Jonathan Ringvald in August 3rd, 2021

Click-baity title aside, my assessment is that industry classification is a broken process at best. The concept of gathering an entire population of businesses, then determining a set of limited categories for that entire population is a task monumental at best, and impossible at worst. But there are solutions (or workarounds). As always, we start with the problems, then offer up a few helpful suggestions to navigate. Here we go...

Gaps in the taxonomy

Every taxonomy, or categorization system will naturally have some blind spots. Even the system that categorizes the animal kingdom has issues. As new species are discovered, oftentimes they don't fit into a particular bucket, and need to be given their own. Industry taxonomy isn't nearly that adaptive. When a business doesn't quite fit into a mold, it is given a generic "other" category, which is often unhelpful or downright detrimental to business processes.

These gaps do have a root issue. They're primarily caused by...

Lack of, or slow industry classification standards updates

Industry Classification standards don't update often. Typically they'll update alongside a government's census. In the case of NAICS (which Relativity6 classifies for), the standard only updates once every 5 years. Taking into account that NAICS is a government driven standard, and there's only so many resources that can be allocated, it's understandable.

If you can imagine for a second, all the new industries have been developed or have become more common since 2017.

The cannabis industry has doubled in size since 2017 and the crypto industry has similarly appeared out of nowhere since that time. The pace of business innovation has decidedly outpaced any classification system.

Not only do overall industries change, but individual...

Businesses change too

The reality of entrepreneurship is that businesses pivot and change throughout their lifetimes. Even though a business founder may have had one vision for her company, she may have changed that direction for any number of reasons.

The dynamic nature of business was no more apparent than during the covid-19 pandemic. Brick and mortar businesses that were too stubborn to go digital were at a disadvantage as mandates closed down economic city centers and towns across the world. For example, Shopify, an online e-commerce platform saw their customer numbers skyrocket as retailers shuttered their storefronts and moved their operations online.

Businesses have multiple revenue streams

Industry classification systems and the processes that rely on them are asking for primary codes. Meaning they want to know how a business brings in their most revenue. But what if that business isn't so straight forward. Many companies rely on more than one line of business or product contributing to revenue. Businesses in industries like construction and contracting often rely on several different sources of income. The residential remodeler might also spend 30% of their time fixing roofs, or the ad agency could bring in half their revenue from video production.

Solutions

Industry classification has been around for more than 100 years. Updated classes every 5 or so years might have been ok in 1960, but the pace of change is just too rapid in 2021.

The NAICS convention is coming up in 2022 to determine the taxonomy for the next 5 years. Suggestions can be sent to the committee for taxonomic changes. Based on our research, our team will be sending several suggestions for changes that would be reflect the current business climate.

While these committees get together, inside of your company you can create your own taxonomy. This system would be unique to your customer base, and give a good sense of what types of companies rely on your products.

As a community, we should also make it acceptable to give multiple industry classifications when labeling and segmenting companies. If a company does more than one thing, that labeling is more reflective of the ground truth of that entity's activities and revenue.

Embracing the dynamic nature of business is also important. It's incredibly effective to know if and when a business has pivoted or added a new line of business. Regularly auditing your customer population will give you an up to date understanding of how best to communicate and serve them.

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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