Major Industry Classification Systems around the World – Part 1

This is part of my series on industry/vertical classification. In my previous article, What Is Industry Classification, I defined industry classification by breaking it up into two processes: grouping and classification.

Now let’s look at what are the major classification systems around the world and how do they work. Because there is a lot to cover, I will break this into two parts:

• Part 1 will discuss major industry classification systems, like the SIC, NAICs, but from a grouping/aggregation perspective
• Part 2 will be from the classification perspective

Market vs Production Views of Industry Grouping

Most of us probably have heard of SIC, NAICS, or NACE (if you are from Europe), right? Many assume that these are the only ways to classify industries. This is not true. There are actually two approaches to when it comes to industry: market vs production. To put it simply, the former focuses more on "output" and the latter on "input."

The production oriented/based is much more widely used: it is used by most statistical bureaus, national accounts, and trade commissions around the world. However, these two approaches are not mutually exclusive, and they often do overlap. In practice, most research houses and companies use a blend of the two, and for good reasons.

Market or Demand-Oriented Approach

Market approach group companies based on the types of buyers they sell to or serve, what problems does it solve, and other buyer behavior attributes. We will give a quick example here.

Global Industry Classification Standard (GICS)

A well-known market-oriented industry classification system is the Global Industry Classification Standard (GICS).?It was developed in 1999 by MSCI in collaboration with S&P Dow Jones Indices. Standard & Poor industry reports are based on this system.

Highlights of GICS system:

• Objective is to help compare firms' financial performance against their peers in the same industry
• Used by the investment community
• Classifies mostly publicly traded firms only
• Has 4 levels: 11 Sectors, 24 Industry Groups, 69 Industries, and 158 Sub-Industries
• Grouping is more oriented towards the type of customers, business model/operating margin, etc.
• Accommodate "conglomerates", i.e., have industry codes such as "diversified financials", "diversified”, which makes classification easier
• Classification rules and methodology are clearly defined and rely on reported revenue segments

Most large publicly traded firms can be classified nicely into the GICS.?For example, GICS breaks down the economy into:

• Energy
• Materials
• Industrials
• Consumer Discretionary
• Consumer Staple
• Health Care
• Financials
• Information Technology
• Communication Services
• Utilities
• Real Estate

Oil and Gas is tugged nicely under Energy sector as its own industry (production-oriented approach, like ours, scatters upstream, mid-stream, downstream into resources, transportation, manufacturing, and retail). ?Medical devices, pharma/life sciences, payer, and provider are all under health care, whereas production-oriented approach will classify them under manufacturing, insurance, healthcare provider.

However, this approach has some shortcomings:

• It is not widely adopted by major government statistics offices, such Eurostat, US Census Bureau, BLS (Bureau of Labor Statistics), National Statistics Bureau (China); therefore, it is difficult to correlate data to data from most national accounts (gov't bodies responsible for GDP), labor data, inflation, etc.
• Usually, when developing a new classification system or a revision of an existing system, efforts are made to ensure continuity between the new system and previous system. The historical continuity can help analyze long-term changes in economic activity (the old vs new industries.) Because GICS was developed only 20 or so years ago and did not attempt to capture historical industries, it laced historical continuity. For example, kerosene refining used to be the main purpose of petroleum refining because people depended mainly on kerosene fuel for lighting, but it because largely obsolete after electronification and companies like the Standard Oils moved onto gasoline, diesel, and other chemicals, but some other industry classification systems still retained this activity for historical continuity. GICS does not call out this activity specifically.

In summary, GICS is more for investors but not for economists. Also, from a go-to-market/sales perspective, it works quite nicely.

Production-Oriented Approach

The more well-known industry classification systems are production oriented. ?This group includes SIC (Standard Industry Classification), International Standard Industrial Classification of All Economic Activities (ISIC), North American Industry Classification System, just to name a few.

Standard Industrial Classification (SIC)

Established in the United States in 1937, Standard Industrial Classification (SIC) is used by government agencies to classify industry areas. It was first developed by the US Statistics Committee to unify different systems by different US government agencies. The SIC system is also used by agencies in other countries, e.g., by the United Kingdom's Companies House (Source: Wikipedia, The History of SIC).

SIC is considered the first industry classification system adopted worldwide. It was last updated in 1987. While SIC was supposed to be replaced by NAICS, it is still used by some government agencies such as the US Securities and Exchange Commission (SEC), the US Trade Commission, as well as private research firms, such as Dun & Bradstreet. Some private data firms maintain other classification systems as well, i.e., DnB has both SIC and NAICS.

SIC is a 4-digit hierarchical classification system. However, over the years, other agencies and private firms have added additional 2-to-4 "extension digits" to give it granularity, but these are not considered standard codes.

The North American Industry Classification System (NAICS)

NAICS is a classification of business establishments by type of economic activity (process of production). It is used by government and business in Canada, Mexico, and the United States of America.

NAICS is a collaborative effort by Mexico's Instituto Nacional de Estadística y Geografía (INEGI), Statistics Canada, and the United States Office of Management and Budget (OMB), through its Economic Classification Policy Committee (ECPC), staffed by the Bureau of Economic Analysis (BEA), the Bureau of Labor Statistics (BLS), and the Census Bureau (Wikipedia).

NAICS is a 6-digit hierarchical system, but the last digit is reserved to differentiate Canada, Mexico, and US industries; therefore, for most firms, 5 digit is commonly used (the last digit is just set to zero.)

International Standard Industrial Classification (ISIC)

The International Standard Industrial Classification of All Economic Activities (ISIC) is a industry classification system developed by the United Nations (Wikipedia). It is a 4-digit hierarchical system, and one of my favorites.

Statistical Classification of Economic Activities in the European Community (NACE)

NACE is derived from the French term "nomenclature statistique des activités économiques dans la Communauté européenne"). It is the industry standard classification system used in the European Union. The current version is revision 2 and was established by Regulation (EC) No 1893/2006. It is the European implementation of the UN classification ISIC, revision 4 (Wikipedia).

NACE is also a 4-digit classification system, and it is largely identical to ISIC, except for small differences at the very granular level.

How The Four Systems Related to Each Other

All major production-oriented classification systems follow the primary, secondary, and tertiary industry progression – start from pure agricultural, to mining, to making basic materials, to making final products, eventually to "pure" service - almost like walking down the "industrial revolution hallway" of the modern history museum.

NAICS, ISIC, and NACE all largely originated from SIC and can be seen as a continuation of SIC.

However, there are three major breakaways from the old SIC to the new NAICS, ISIC, and NACE systems:

• The manufacturing view gives away to the services view
• Many integrated economic activities have disaggregated and specialized: globalization
• Technological changes: mainly the rise of information technology

For example, unlike SIC, NAICS, ISIC, and NACE have Information and Communication separated out as a stand-alone broad-level group, to address IT related activities. In SIC, software and IT services are classified the same 3-digit level - 737 (7371-7379). In NAICS, packaged software (Microsoft, SAP, Oracle, etc.) are now under information and communication but let IT services remain under professional and technical services. ISIC and NACE, on the other hand, have shifted both software and IT services to under Sector-J Information and communication.?

Few other differences between the three with SIC include:

• Many repairs and maintenance related activities from manufacturing activities of the same products are separated out.
• NACE and ISIC also provided new rules on how to treat outsourcing services.

ISIC and NACE are practically identical as NACE was derived from ISIC, with some differences at the more granular level. ISIC also derived some of its core innerworkings from NAICS. Therefore, NAICS, at least at the 5-digit level, are somewhat similar to the other two.

However, between the older to the new and vice versa is not so simple, even within the same classification system.

ISIC manual stated that "At the highest level of ISIC, some sections can be easily compared to the previous version of the classification. Unfortunately, the introduction of a number of new concepts at the section level of ISIC (e.g., section J, “Information and communication”) make it impossible to achieve an easy overall comparison between ISIC, Rev.4 and the previous version of the classification." (Source: ISIC Rev 4, page 12.)

As a result, SIC codes do not always translate nicely to the other three and vice versa, despite one of the largest myths in the market research industry led people to believe. It is far more accurate and honest to say that SIC can be "approximated" to NAICS and vice versa.

The following tables provide a few examples:

Source: NAICS Crosswalk, Eurostat RAMON

In the next post, I will get into some of the nitty-gritty of these systems by looking at how the classification part. Stay TUNED!