A Tip about Tips
It’s Saturday evening. You feel the urge to go to your favourite restaurant so you visit the place and order your favourite cuisine. The waiter courteously serves you hot, delicious meals with swift service. At the time of payment, you pay the bill amount and a little extra - something commonly known as a “tip”, a reward for the waiter’s kind service.
Gratuity payments received by employees from the food industry comprise a gigantic portion of an economy’s gratuity income in total. According to a 2011 estimate, the food industry in the US reflected annual tips of about $47 billion. Thus, it is only safe to assume that the number has increased significantly due to the improvement in different socio-economic factors such as standard of living, consumer preferences and so on.
The strange tipping behaviour makes us ponder certain questions such as why do we leave a “tip”? Who do we think deserves the tip more? The chef who spends hours inside the scorching kitchen to prepare the meal or the waiter who carries a few plates from one place to the other in an air-conditioned room? Moreover, is it rational to pay more than the bill amount for the services received? Find the answers to all these questions below
Why do we tip then?
It is difficult to explain the tipping behaviour of a consumer because a tip is generally given after the service has been rendered. Thus, there exists no economic motivation for a consumer to pay more than what he was asked for. One might argue that if the consumer is in a repeated relationship with the seller of a good or a service, where the qualities of the seller matter to the consumer’s utility; the consumer then has an economic motive to show his kindness. However, people also provide gratuity payments at places that they are unlikely to revisit, for instance, a restaurant they went to while on a vacation. Hence, by that logic, we conclude that future service is not a significant reason to explain tipping.
Reasons for tipping based on Azar (2010)
Thus, leaving behind only psychological and social motivations as reasons to explain such a behaviour by a rational consumer. It is reported that a consumer who was happy before entering the restaurant is more likely to leave a larger tip than a customer who liked the service of the restaurant. In conclusion, pinpointing a particular reason to justify tipping would be impossible and be synonymous with finding a needle in a haystack.
A problem that gratuity payments solve…
The principal-agent problem arises when the person you hire to do your bidding doesn’t act according to your best interests. To sell your house you employ a realtor, to represent you in legal proceedings you hire a lawyer, the principal-agent problem arises when the interests of these service providers do not align with their employers. For example, you might want to sell your house at the best price, however, the realtor wants to sell the house as fast as possible. Making an extra $10,000 from the sale of your house is a big deal to you, but not to the realtor who only makes a small commission from the sale.
While it is extremely difficult for the owner of the restaurant to monitor each and every server all the time, the customer is in the best position to do so. Thus, by offering the meals at a lower price, the owners presumably provide a lower base wage allowing the customers to compensate for the difference depending on their assessment of the service they’ve received. The presence of tips incentivises the server to give their best as it directly impacts the reward they receive. This not only reduces monitoring costs but also solves the principal-agent problem.
A problem that gratuity payments do not solve…
A restaurant owner has two choices, either pay their employees the minimum wage rate or let the tips paid by its customers make up for the difference between the wage they pay and the wage they are supposed to pay.
When the owner chooses the former, the owner increases the menu prices of his dishes to compensate for the increased costs and reduced consumer demand that it entails. When the owner chooses the latter, he cunningly adds something known as a “service charge” (not to be confused with the “service tax” that was replaced by the GST in India in 2017) as a percentage of the total bill amount which the consumer has the option to pay or not to pay. Often, the owners get lucky when customers that don’t pay such attention to detail end up paying the optional amount. And in areas with more careful customers, the owners rarely get lucky.
Hence, if the owner chooses to increase its prices, it faces reduced demand. If he chooses to levy the optional service charge, he faces the risk of not complying with the law that requires him to pay the minimum wage rate. What does the restaurant owner choose?
The problem is not restricted to restaurant owners only. Many organisations such as Ola, Uber, Zomato, and so on, have chosen the former by adding a tipping feature in their apps. Through the feature, the users can choose to tip the service provider according to their preferences at the time of payment. Uber launched the tipping feature in the US in 2017, and in just one year, it is estimated that it received as much as $600 million in tipping income. In India, however, since Gen Z and the millennials (popularly known as the worst tippers among service providers) make the most use of these apps, the tipping income may not be that high but it is substantial.
On the one hand, we have the cooks who actually prepare the meals for us, on the other, we have the servers who act as de facto babysitters and therapists for their customers. Hence, while logic may dictate that cooks should be the ones receiving the tip, the level of ignorance and arrogance in some customers that waiters have to deal with can’t be ignored. A solution would be for restaurants to have a “tip-out” policy, wherein waiters need to share a part of their tips with the cooks. To sum it up, while it may be a flawed practice from an economist’s perspective to tip… on a human level, one’s benevolence might just make the day for their servers.
The Economics of tipping by Ofer H. Azar
Author: Neeraj Agarwal
Illustration by: Tanmay Chowdhary