Industry

What Is NAICS?

The North American Industry Classification System (NAICS), pronounced "Nakes," is a standard for classifying business establishments by type of economic activity. This system falls under the broader category of economic classification and is primarily used by federal statistical agencies in the United States, Canada, and Mexico to collect, analyze, and publish economic data. The NAICS code assigned to an establishment reflects its primary business function, enabling consistent statistical analysis and comparability across North America.

History and Origin

The development of the North American Industry Classification System (NAICS) was a direct response to the need for a modern system that could better reflect the evolving economies of North America. Prior to NAICS, the United States primarily used the Standard Industrial Classification (SIC) system, which had its origins in the 1930s and was last updated in 1987¹⁰, ¹¹. However, rapid changes in the U.S. and global economies highlighted the limitations of the SIC system, particularly its struggle to adequately classify emerging industries and services⁹.

In the early 1990s, the U.S. Office of Management and Budget (OMB) initiated a review of the economic classification system. In July 1992, the OMB established the Economic Classification Policy Committee (ECPC), which collaborated with Statistics Canada and Mexico's Instituto Nacional de Estadística y Geografía (INEGI) to create a new, shared classification system. ⁷, ⁸This collaborative effort aimed to enhance comparability of industry statistics across the three countries. ⁶The intention to revise the SIC for 1997 and introduce the new system was formally announced in the Federal Register in March 1993. ⁵The first version of NAICS was officially adopted and implemented in 1997, marking a significant advancement in how industries are categorized across the continent.
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Key Takeaways

• NAICS is a collaborative industry classification system used by the United States, Canada, and Mexico.
• It replaced the older Standard Industrial Classification (SIC) system in 1997 to better reflect modern economic activities.
• NAICS codes are hierarchical, typically six digits, allowing for detailed classification of business establishments.
• The system facilitates the collection, analysis, and comparability of economic data across North America.
• NAICS is reviewed and updated every five years to remain relevant to the changing economic landscape.

Interpreting the NAICS

NAICS codes are structured hierarchically, providing increasingly specific levels of detail about an establishment's primary economic activity. A typical NAICS code consists of six digits:

• First two digits: Designate the economic sector (e.g., 54 for Professional, Scientific, and Technical Services). There are 20 sectors in the 2022 NAICS United States system.
  ²* Third digit: Represents the subsector within that sector.
• Fourth digit: Identifies the industry group.
• Fifth digit: Specifies the NAICS industry.
• Sixth digit: Designates the national industry, allowing for country-specific detail beyond the North American commonality.

This hierarchical structure allows for a granular understanding of industries, from broad sectors like manufacturing or retail trade down to very specific activities within those sectors, aiding in market segmentation and analysis.

Hypothetical Example

Imagine a small business that specializes in developing custom software solutions for other companies. To understand its place within the broader economy, this business would be assigned a NAICS code.

Let's break down a hypothetical code:

• 54: Professional, Scientific, and Technical Services (Sector)
• 541: Professional, Scientific, and Technical Services (Subsector)
• 5415: Computer Systems Design and Related Services (Industry Group)
• 54151: Computer Systems Design and Related Services (NAICS Industry)
• 541511: Custom Computer Programming Services (National Industry)

This specific NAICS code (541511) clearly identifies the business as primarily engaged in writing, modifying, testing, and supporting software to meet the needs of a particular client. This classification would be crucial for the business when applying for certain types of government contracting opportunities or when conducting market research to identify competitors or target clients.

Practical Applications

The North American Industry Classification System has widespread practical applications across various economic and financial domains. Government agencies heavily rely on NAICS for collecting, compiling, and publishing statistical data related to the U.S. economy, such as the U.S. Economic Census. This data is vital for understanding economic trends, informing public policy, and monitoring changes in industries and employment.
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Businesses frequently use NAICS codes for various purposes, including applying for tax incentives, registering for government contracts, and conducting competitive market analysis. Financial institutions and investors may utilize NAICS codes to categorize companies, assess industry risks, and perform due diligence in investment decisions, contributing to informed financial reporting. Researchers and academics also leverage NAICS data to study economic phenomena, analyze business cycles, and gain insights into macroeconomics.

Limitations and Criticisms

Despite its comprehensive nature and broad adoption, NAICS is not without limitations or criticisms. One common challenge is that the system, while regularly updated, can sometimes lag in fully capturing rapidly emerging industries or significantly new forms of economic activity. For instance, an entirely new technology sector might take time to be adequately represented and classified within the existing structure during the five-year revision cycle.

Another point of consideration is the occasional lack of direct comparability with older classification systems. While NAICS largely replaced the SIC system, some government agencies, such as the U.S. Securities and Exchange Commission (SEC), continue to rely on SIC codes for classifying public companies. This can create inconsistencies when comparing historical data or when navigating different regulatory or statistical requirements that use varying classification standards. Furthermore, assigning a single NAICS code to a multi-faceted business can be challenging, as many modern enterprises engage in diverse activities that might span multiple industry classifications. This can sometimes oversimplify a company's true operational scope.

NAICS vs. SIC

The primary difference between the North American Industry Classification System (NAICS) and the Standard Industrial Classification (SIC) system lies in their scope, structure, and underlying philosophy. The SIC system, developed in the 1930s, was primarily a U.S.-centric classification based on production processes and was less adaptable to emerging service industries. Its four-digit code structure provided less detail compared to NAICS.

In contrast, NAICS was developed as a collaborative effort among the U.S., Canada, and Mexico, emphasizing comparability across North America. It uses a more detailed six-digit hierarchical structure that better accommodates the modern, globalized economy, particularly the growth of the service sector and information-based industries. While both systems aim for industry classification, NAICS offers a more granular and internationally aligned approach to categorizing business establishments.

FAQs

What is the purpose of NAICS?

The main purpose of NAICS is to provide a standardized system for classifying business establishments by their primary economic activity. This allows federal statistical agencies in the U.S., Canada, and Mexico to collect, analyze, and publish comparable economic data across North America.

How often is NAICS updated?

NAICS is reviewed and updated every five years by the collaborating countries (U.S., Canada, and Mexico). These revisions ensure the system remains relevant and accurately reflects changes and developments in the North American economies.

Who uses NAICS codes?

Various entities use NAICS codes, including government agencies for statistical purposes and government contracting, businesses for identifying markets, applying for grants or tax incentives, and financial analysts for industry analysis and investment research.

Can a business have more than one NAICS code?

While a business establishment is typically assigned a single NAICS code based on its primary revenue-generating activity, large companies with diverse operations across multiple locations or distinct business segments might have different NAICS codes for each establishment. However, each individual establishment is generally classified under one primary code.

Where can I find my business's NAICS code?

Businesses often determine their NAICS code based on their main activities. Official government websites, such as the U.S. Census Bureau, provide tools and manuals to help businesses identify their appropriate NAICS code.