Naics

What Is NAICS?

The North American Industry Classification System (NAICS) is a standardized system used by federal statistical agencies in Canada, Mexico, and the United States for classifying business establishments by their primary type of economic activity. This system falls under the broader category of economic classification, providing a consistent framework for data collection, statistical analysis, and publishing of economic data across North America. The NAICS assigns a unique six-digit code to each industry, facilitating comparability of industry statistics among the three countries³².

History and Origin

The NAICS system was developed in the early 1990s as a collaborative effort by the U.S. Economic Classification Policy Committee (ECPC), Statistics Canada, and Mexico's Instituto Nacional de Estadística y Geografía (INEGI). ³¹It was officially adopted in 1997, replacing the outdated Standard Industrial Classification (SIC) system. ²⁹, ³⁰The transition to NAICS was driven by the need for a more comprehensive and flexible system that could better reflect the evolving North American economies, particularly the rapid growth of the service sector and the increased economic integration brought about by agreements like the North American Free Trade Agreement (NAFTA). ²⁷, ²⁸The older SIC system, developed in the 1930s, struggled to keep pace with these changes, often lumping emerging industries into broad categories. ²⁵, ²⁶NAICS was designed to offer enhanced coverage, particularly for service industries, and is periodically revised to maintain its relevance, with the latest update occurring in 2022.
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Key Takeaways

• NAICS is a six-digit hierarchical coding system used by North American governments to classify businesses by primary economic activity.
• It replaced the Standard Industrial Classification (SIC) system in 1997 to better reflect modern economies and facilitate cross-border data comparability.
• Businesses use NAICS codes for government reporting, contracting, market analysis, and identifying potential tax incentives.
• NAICS codes are self-assigned by businesses based on their predominant activity.
• While widely used, NAICS codes have limitations, including their broad categories and periodic update schedule, which may not always capture rapidly emerging industries.

Interpreting the NAICS

The NAICS employs a hierarchical structure, typically using a six-digit code to classify economic activities into industry sectors. The first two digits of a NAICS code designate the largest business sector (e.g., 54 for Professional, Scientific, and Technical Services). The third digit represents the subsector, the fourth digit identifies the industry group, the fifth digit specifies the NAICS industry, and the sixth digit represents the national industry. ²³This hierarchical breakdown allows for increasingly granular classification, providing a detailed understanding of specific business activities within the broader economic landscape. For instance, a general sector like "Manufacturing" (31-33) can be drilled down to specific manufacturing industries. ²²This systematic organization aids in various forms of industry analysis.

Hypothetical Example

Consider "Innovate Tech Solutions LLC," a new company that primarily develops custom software for businesses. To classify itself within the NAICS system, Innovate Tech Solutions would look for the code that best describes its main economic activity.

• They would start with the two-digit sector. Given their focus on software, the "Information" sector (51) is a strong candidate.
• Moving to the three-digit subsector, they might find "Software Publishers" (5112).
• Further refining to the four-digit industry group, "Software Publishers" (5112) is still applicable.
• At the five-digit industry level, they might identify "Software Publishers" (51121).
• Finally, at the six-digit national industry level, if their work is primarily custom software development, they might fall under "Custom Computer Programming Services" (541511), which is a different sector (Professional, Scientific, and Technical Services).

This example highlights that a business must carefully assess its primary activity to ensure it selects the most appropriate NAICS code, even if it performs multiple functions.

Practical Applications

NAICS codes serve numerous practical applications across government, business, and research. Government agencies, such as the U.S. Census Bureau and the Bureau of Labor Statistics, use NAICS codes to collect, analyze, and publish vital economic data like employment statistics, payroll figures, and industry output. ²⁰, ²¹This data is crucial for understanding economic trends, formulating policy, and compiling national accounts.

For businesses, NAICS codes are essential for participating in government contracts and procurement processes, as many solicitations are defined by specific NAICS codes and associated size standards. ¹⁸, ¹⁹They also play a role in identifying eligibility for various tax incentives and government programs. ¹⁶, ¹⁷In the private sector, businesses leverage NAICS codes for market research, competitor analysis, and identifying target audiences for marketing and sales efforts. ¹⁴, ¹⁵For example, a company looking to sell equipment to manufacturing firms could use specific manufacturing NAICS codes to identify potential clients.

Limitations and Criticisms

Despite its widespread adoption and utility, the NAICS system has certain limitations and criticisms. One common critique is the inherent challenge of its periodic updates, typically every five years, which can mean that the system may not always reflect rapid shifts or the emergence of entirely new industries in a dynamic economy. ¹³This can lead to new business models or niche industries being grouped into overly broad categories, potentially obscuring their true economic impact or making detailed industry trends difficult to track.
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Another limitation arises in the self-assignment process of NAICS codes. While businesses are expected to choose the code that best represents their primary activity, this can sometimes be subjective, especially for diversified companies or those with hybrid business models. ⁹, ¹⁰In government contracting, the selection of an inappropriate NAICS code can significantly impact a small business's eligibility for set-aside contracts or influence its perceived size standard, leading to challenges or appeals. ⁸Reviews by the U.S. Government Accountability Office (GAO) have found inconsistencies in NAICS code assignments for similar procurements, and while appeals are possible, they have a relatively low success rate, requiring proof of clear error.
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NAICS vs. SIC

The North American Industry Classification System (NAICS) largely superseded the Standard Industrial Classification (SIC) system, though SIC codes are still used by some agencies, such as the U.S. Securities and Exchange Commission (SEC). The fundamental difference lies in their approach and scope.

While both systems aim to categorize business establishments, NAICS offers a more detailed and flexible structure better suited to modern economies. The transition from SIC to NAICS was a significant step towards standardizing financial reporting and economic analysis across the North American continent.

FAQs

How do businesses get a NAICS code?

Businesses self-assign their NAICS code based on their primary economic activity. The U.S. Census Bureau's official NAICS website provides a searchable database and manual to help businesses identify the most appropriate code for their operations.
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Why is having the correct NAICS code important?

Having the correct NAICS code is crucial for several reasons: it affects eligibility for government contracts and grants, impacts tax incentives, influences market research and competitive analysis, and ensures accurate government data collection related to specific industries. ³, ⁴An incorrect code can lead to missed opportunities or misrepresentation in statistical data.

How often are NAICS codes updated?

NAICS codes are typically reviewed and updated every five years to reflect changes in the economy and the emergence of new industries. ²Businesses should periodically review their assigned code to ensure it still accurately reflects their primary business activities.

Can a business have more than one NAICS code?

While a business should primarily use one NAICS code that best describes its main activity, a diversified company with multiple distinct lines of business may use more than one NAICS code to classify its different operations for internal tracking or reporting to various agencies. ¹However, for most government reporting or contracting, a single, primary NAICS code is usually required.