BUS501: Strategic Management

An establishment is classified in an industry when its primary activity meets the definition for that industry. Because establishments may perform more than one activity, it is necessary to determine procedures for identifying the primary activity of the establishment.

In most cases, if an establishment is engaged in more than one activity, the industry code is assigned based on the establishment's principal product or group of products produced or distributed, or services rendered. Ideally, the principal good or service should be determined by its relative share of current production costs and capital investment at the establishment. In practice, however, it is often necessary to use other variables such as revenue, shipments, or employment as proxies for measuring significance.

There are two types of combined activities that are given special attention in NAICS. They are vertical integration and joint production. These combined activities have an economic basis and occur in both goods-producing and services-producing sectors. In some cases, there are efficiencies to be gained from combining certain activities in the same establishment. Some of these combinations occur so commonly or frequently that their combination can be treated as a third activity in its own right and explicitly classified in a specific industry.

One approach to classifying these activities would be to use the primary activity rule, that is, whichever activity is largest. However, the fundamental principle of NAICS is that establishments that employ the same production process should be classified in the same industry. If the premise that the combined activities correspond to a distinct third activity is accepted, then using the primary activity rule would place establishments performing the same combination of activities in different industries, thereby violating the production principle of NAICS. A second reason for NAICS recognizing combined activities is to improve the stability of establishment classification, both over time and among the various agencies that implement the classification. An establishment should remain classified in the same industry unless its production process changes, and different agencies should code the same establishment or type of establishment in the same way. A consistent treatment of establishments with combined activities is more likely if they are classified to a single industry.

Vertical integration involves consecutive stages of fabrication or production processes in which the output of one step is the input of the next. In general, establishments are classified based on the final process in a vertically integrated production environment, unless specifically identified as classified in another industry. For example, paper may be produced either by establishments that first produce pulp and then consume that pulp to produce paper or by those establishments producing paper from purchased pulp. NAICS explicitly specifies that both of these types of paper-producing processes should be classified in NAICS 32212, Paper Mills, the final step in paper manufacturing, rather than in NAICS 32211, Pulp Mills. In other cases, NAICS specifies that vertically integrated establishments are classified in the industry representing the first stage of the manufacturing process. For example, steel mills that make steel and also perform other activities such as producing steel castings are classified in NAICS 33111, Iron and Steel Mills and Ferroalloy Manufacturing, the first stage of the manufacturing process.

The joint production of goods or services represents the second type of combined activities. For example, automobile dealers both sell and repair autos; automotive parts dealers may both sell parts and repair automobiles; and musical instrument stores may both sell and rent instruments. In the Manufacturing sector, establishments may make two different products such as men's suits and women's suits, activities that are classified in two different NAICS United States detailed industries. In general, receipts/sales and revenue data are used as a proxy to determine primary activity for these establishments. The assumption is that the activity generating the most receipts is also the activity using the most resources and most indicative of the production process.

In some cases, however, these combined activities have been assigned to a specific NAICS industry. Most of these activities involve either the sale and repair of goods or the sale and rental of goods in the same establishment. For example, establishments that both sell automobile parts and repair automobiles are classified in NAICS 44131, Automotive Parts and Accessories Stores, and music stores that both sell and rent musical instruments are classified in NAICS 45114, Musical Instrument and Supplies Stores. In other cases, specific industries are identified for these combined activities, such as NAICS 44711, Gasoline Stations with Convenience Stores.

Classification rules related to the agreement to permit individual country detail at the six-digit level for NAICS sometimes result in less comparable NAICS industries at the five-digit level and above. For example in NAICS, the assignment of the industry code is at the most detailed level of the classification (the six-digit U.S. detail code), except for Agriculture. That is, if the value of an establishment's production consists of 30 percent from computers, 30 percent from computer storage devices, and 40 percent from semiconductors and related devices, it is classified in U.S. detail industry 334413, Semiconductor and Related Device Manufacturing, that is aggregated to NAICS 33441, Semiconductor and Other Electronic Component Manufacturing, the level that comparable information is shown for all three countries. If the classification for the above example were at the five-digit NAICS level, that establishment would be classified in NAICS 33411, Computer and Peripheral Equipment Manufacturing. There would then be more comparable information at the NAICS level, but it would be impossible to classify this establishment to a U.S. detail six-digit industry.

In Agriculture, however, NAICS coding begins at the top of the structure and continues down to the most detailed level (the six-digit U.S. detail code). The existence of a 50 percent rule in Agriculture and the presence of combination industries based on families of related agricultural products with none accounting for 50 percent or more of production require a top down coding procedure rather than coding at the most detailed level first as is done in the balance of the classification.