23 November 2015

Tipping: Perfect Market Efficiency or Lazy Employers?

Olivia writes:*

In the Netherlands, I have often faced a moral dilemma when it came to paying the bill in restaurants. How do I tip? Back in Austria, it was straightforward: You just round up the number on the bottom of the bill, maybe add another Euro or two. But living in the Netherlands has made me used to paying by debit card – which makes the whole tipping procedure slightly tricky. Do I cross out the number on the bill and write down a new amount? Leave coins on the table? Or neither? Over time and by observing how my Dutch friends solve this dilemma, I got used to the latter option: I do not tip any more. Realizing this change in my behavior, I began wondering about apparently (one of economists' favorite topics): why do people tip in the first place? Explanations range from increasing market efficiency to the satisfying feeling of having done something good – but what I am interested in are the economic incentives for a better service based on tipping. Ignoring the studies that find that tipping is based on many other factors than the quality of service (check out Michael Lynn's research here if you are interested), what do these incentives theoretically mean for the parties involved?

The Customer

As the customer, I am the person to reward good service with a higher tip. At the cost of some extra-Euros, I (hopefully) benefit from better service. However, for a single customer it does not seem rational to give a tip: by the time you do, the service has already been performed and unless you are a frequent at the given bar, you are not likely to suffer from any future consequences. However, disappearance of tips on a larger scale could mean worse service for everyone. If there is no expectation of a reward anyways, why should the waiter or waitress bother to make a customer extra-happy?

The Waiter or Waitress

If tips are given as incentives, the quality of restaurant-service logically should decrease when costumers stop to give tips. From my two-country-comparison of Austria and the Netherlands, I have not observed any of the like – the service in both countries shows that there is a lot of variation between waiters and waitresses, which does not seem to be related to the habit of (non-)tipping in either country. Why would that be? Regardless of the whole waiter/waitress-costumer-interaction, every waiter and waitress is still employed by the restaurant owner. Like in any other job, the main incentive to perform well is to not get fired. Tipping is in that case not part of the story.

The Restaurant Owner

From the restaurant owner's perspective, tipping is great. When one of his or her employees complains about their low wage, (s)he can simply refer to tips: “if you perform better, you get more tips” – tipping is used as a bonus paid by another party, the costumers. The restaurant owner thereby not only outsources part of the costs, but also the monitoring. Instead of checking each waiter's and waitress's performance in order to then warn or punish them, the costumer takes this role for the restaurant owner. “The market of good service and costumer tips is perfectly efficient,” the restaurant owner would argue. My conclusion on the other hand is that the restaurant owner is too lazy to deal with monitoring and providing other incentives.

Bottom Line:  Customer service would be just as fine without tipping, but restaurant owners would have to monitor their employees' performance better and consider other incentives for the waiters and waitresses to perform well.

* Please comment on these posts from my microeconomics students, to help them with unclear analysis, other perspectives, data sources, etc.

8 comments:

  1. Very interesting piece, always important to keep in mind how headlines to favour policy can be undermined by data and statistics. Looking forward to your presentation.

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  2. Very interesting analysis! I was wondering whether you considered the possible intrinsic and altruistic motivations of the costumer which makes tipping a perfectly rational decision? Tipping has become very integrated in our society, which is why often when paying the bill I tend to tip at least a small amount, even when I think the service was bad. Tipping a small amount is seen as the norm, and by not following the norm awkward encounters might occur with the waiter/waitress. Also, when I don't tip I often feel bad about myself because I know it was sort of expected from me and tipping it only costs me a little bit of money. So, I think this is also an important reason as to why people tip

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  3. Yes, I thought about intrinsic motivations as well and what you say also makes perfectly sense. For the sake of keeping the post short, I only stuck to some "outside incentives" - but of course, expectations and emotions also play a role and should not be ignored when making a holistic analysis.

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  4. This is an interesting phenomena you have approached, and as you mentioned it is a real subject of debate in microeconomics. Your approach to this debate, that is, using two countries to compare different tendencies, is original. It is also crucial because it shows that such phenomenon are not entirely anchored in economics. Indeed, as you mentioned one culture responds differently to tipping than another, which shows that values and standards bring nuance to economic debates (and how individuals are "rational" in different ways).

    The structure of your argument is nice because it really helps to comprehend how different parties react to another's choice and how in turn this affects the first party. Also, as you say it shows how tips are used as incentives from both the costumers and the owners of the restaurant (who use it a more or less reasonable justification for poor salaries).

    Great analysis, and that deserves a little more words and time if it was possible.

    Juliana R

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  5. Great analysis, Olivia. Very clear and a good division between which incentives are faced by which party. I believe it is unfortunate, however, that you decided to leave out the effect of social norms and general conduct on the incentives of the consumer, as it takes away a large part of the justification for tipping someone.

    I will use the example of the Netherlands to demonstrate how a large part of the tip does not reflect the kindness of the waiter. In the Netherlands, it is the custom to tip between the 5 and 10 percent when you are eating out. A tip of 5% is always expected and if you fail to provide a 5% tip, it is not uncommon for you to be shamed within a group. This means that the first 5% is a bad reflection of the performance of a waiter, as he can expect that amount of money anyway.

    So if the first 5% does not increase the performance of a waiter, what does it do? The first 5% margin mainly sustains a costly monitoring system of in-group punishment. When a tip less than 5% is paid, every individual in the group has to use mental resources to make the non-tipper feel uncomfortable, so that he wants to adhere to the group norm of a 5% tip. The non-tipping individual will waste his social capital in the group, as people will start to see him as 'cheap' and 'greedy'. Therefore, going under the 5% margin will mean the expenditure of both the non-tipper and the 'others' resources

    Bottom line of my argument: Get rid of the social norm that tipping is necessary. A social norm of tipping has no benefit for anybody, as the waiter can expect a certain percentage, and it always has costs, monetary when somebody complies with the system, social when he does not.

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  6. Btw, you probably read them.

    But here are articles I found interesting before in The Economist.
    http://www.economist.com/blogs/gulliver/2015/10/service-compris
    http://www.economist.com/blogs/gulliver/2015/10/keep-your-change

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  7. Thanks guys, you bring up good additions to the discussion on tipping! I also completely agree with you Laurens that the expectation of tips takes away all possible incentives.

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  8. As a seasoned waiter/bartender I find this an interesting topic. If I get it correctly, your argument is that tipping is unnecessary for achieving efficiency/higher productivity from the waiters, because the employer (restaurant owner) should be able to do this himself (through monitoring and providing other incentives), which you believe (s)he should.

    I think this is a possibility, however, I am very much in support of tipping. This is not because I am a waiter and I like receiving tips. (I give tips myself as well!) It is more that I have come to experience the power of tipping through being a waiter which have made me be more conscious about tipping as well.

    If considered only the quality of service, then service is not only provided by a single waiter. It includes the dishwasher which makes sure everything is clean, it includes the host which greets and seats you to your wishes etc. As such, the guest has an important asset with which to rate this service - tipping. If the owner has to oversee all of this, this would significantly increase his costs, which will most likely reduce his surplus, or reduce consumer surplus by charging higher prices.

    Another reason why I value tipping, is that waiters' base salary is very low, basically minimum wage in most cases. The tipping adds extra financial incentives to work hard, such that they can make more money. Restaurant-owners do not have an incentive to provide this (financial) incentive for better-than-average performance from waiters. On the other hand, if all restaurant owners were to impose monitoring and strict rules on service, for only the very low salary that waiters currently get, then I do not think that many people will continue working in this sector, reducing the supply of labor. Or otherwise, waiter can protest/strike for a rise in minimum wage for the hospitality sector (CAO), which would only increase costs for the restaurant owners. (Here is an article about how reduced tipping leads to more unemployment, because the minimum wage is so low: https://www.researchgate.net/publication/239522386_The_Effect_of_the_Tipped_Minimum_Wage_on_Employees_in_the_U.S._Restaurant_Industry)

    With the current system, I think that guests, employers, employees all benefit and it is very difficult to change the system without making others worse off, in this case likely the employees and the employers. Just to stress again, we waiters really rely on your tips to make a decent living. People who work in hospitality get only minimum wage, while working on the most undesirable times and dates of the year, without getting any extra allowances! I hope you can reconsider not tipping, as only tipping sometimes will help a lot!

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