Tipping is widespread across North America. People tip taxicab drivers, hair dressers and hotel doormen. However, the place where the most people tip is in restaurants and bars. The problem for many customers is that tipping is confusing since tipping rules are not clear and payments are arbitrary. Many people agree the “standard” tip is 15%. However, on what amount do you tip 15%? Is it the total bill? Is it the total bill excluding tax? Is it the total food bill, with expensive bottles of wine tipped at a separate rate? Many people agree the tip rate for large groups should often be higher, but how many people comprise a “large” group? Most importantly, tipping means doing math, which is a difficult task for some people and a challenging task after drinking alcohol in a bar or restaurant.
While tipping is confusing and difficult for customers, it is also problematic for workers being tipped. Workers in other occupations know their pay rate before starting work. However, waiters, waitresses and bar tenders often have no idea how much they will earn from a day’s work. Occasionally, servers hit the jackpot and pick up a giant tip. A server at a night club in Connecticut earned almost a $25,000 tip for a few hours of work when a sports team purchased a giant bottle of champagne (details here). A more common experience, however, is for servers to be given little or no tip when customers are angry about their dining experience or when foreign visitors, accustomed to no tipping rules back home, are served.
One reason tipping evolved was because restaurants are unique high risk and high reward businesses. Restaurants often have very high gross profit margins. The US Census Bureau published gross margins as a percent of sales for eating and drinking places from 1909 until 1998. Restaurant margins are the highest in the entire retail category; rising from 52% in 1909 to 66% by 1998. There are relatively few other businesses where only a few dollars of ingredients can be transformed using skill, knowledge, time and energy into amazing and relatively expensive products. For example, yesterday my server convinced me to buy for “only $5.99” a gorgeous slice of chocolate cake for dessert. A slice of chocolate cake costs around twenty-five cents to make, resulting in an exceptionally high markup.
Restaurants and bars, however, are very high risk endeavors. Eating out is a discretionary and relatively expensive activity that can be done at a much cheaper price at home. When the economy dips into a recession, one of the first places many people cut back is eating out. Moreover, there are few barriers to entry in the restaurant business since opening an eatery takes no special degree or required training. Anyone with an idea and a passion to cook can set up shop. This means highly successful restaurants often find competitors opening up quickly nearby to steal away customers and profits. To reduce risk the restaurant business has convinced customers they are responsible for both evaluating and paying the wages of the serving staff.
The TIP was historically a small token payment, designed “To Insure Promptitude.” Today’s tips, however, are not an effective method of motivating servers because tips are given at the end of the meal, not at the beginning. It is hard for a server to be motivated when they have no idea how large an incentive payment they will receive. This problem is borne out by research that found “tipping was not significantly related to servers’ or third-parties’ evaluations of the service.” Many people tip the same amount whether the service is good or bad.
Tips reduce restaurants’ and bars’ direct labor costs, which lowers the risk of these businesses failing. Tips, instead of acting as an incentive, simply shift the burden of paying workers from the business owner to the customer. This shifting has become enshrined in labor law. For example, Federal minimum wage laws state servers only need to be paid $2.13 per hour as long as the rest is made up in tips, ensuring the more customers tip, the less restaurant owners need to pay.
What is another option instead of discretionary tipping? In countries like Japan, there is no tipping or service charge in restaurants. Instead, servers are paid by the company and the price of food and drink is adjusted to account for the extra labor costs.
Shifting to a model where labor costs are built into food and drink prices has many benefits. First, it shifts risk away from workers by eliminating uncertainty and by providing more stability in a server’s pay. Fluctuating pay results in restaurants and bars primarily seeing applicants for server jobs who like, or are able to tolerate, ever changing compensation. Switching to a system of stable pay will help restaurants by expanding the pool of potential applicants to include those who need more income certainty.
Second, building labor costs into menu prices reduces confusion, uncertainty and the need for diners to do math. Eliminating all of these enhance the restaurant and bar experience, increasing the desire to dine out and likely boosting the average check size. Moreover, providing servers with more stable incomes should result in fewer servers quitting over pay issues and concerns. Service quality improves the longer waiters, waitresses and bar tenders stay on the job, since these jobs are far more complicated than they first appear. Finally, given some of the tips paid in cash are not declared on a person’s taxes, shifting to a no-tipping model raises government revenues by reducing the under reporting of income.
Shifting away from a model of discretionary tipping to a model where labor costs are built into menu prices is likely a win for servers, restaurants, customers and the government. Eliminating tipping is a way for restaurants, diners and servers all to have their cake and eat it, too.
Note: A slightly different version of this blog post was published in “The Conversation” on Feb. 20, 2015.