The point of tipping

An old and persistent custom offers rich insight in our profound economic nature

I have to start with an embarrassing confession. On my very first business trip to the US, having arrived on a Saturday evening, I thought I’d treat myself to a proper breakfast the next morning. The bill came to — I remember it well — $12.45, and when I settled it with a $20 note, I left just the small change on the saucer and pocketed the banknotes. The waitress looked distinctly unimpressed at my generosity, but it was only later during my stay that I realized that the American custom of tipping was rather different from what I was used to.

In Belgium, service charges have been included in the prices in bars and restaurants for almost as long as I can remember. Leaving a tip on top of that is neither expected nor common, and even then, most people would simply round off the bill to the nearest full euro. And there is a remarkable variety across countries regarding which professions expect tips, and the typical (or should that be tippical) magnitude of the gratuity. Michael Lynn, a professor at Cornell University and self-confessed tipping expert and Mark Starbuck studied the potential factors behind these differences. The authors propose three key influences: national differences in attitude toward tipping, sensitivity to the duty or obligation to tip, and the sensitivity to social pressure to tip.

The hidden forces behind the tip (source: Tipping Customs: The Effects of National Differences in Attitudes toward Tipping and Sensitivities to Duty and Social Pressure)

Tipping is also an old custom, which some people trace back to the 17thcentury London Coffee Houses (where much business was conducted). Even the term itself would be an acronym (“To Insure Promptness”), but sadly, as the myth busting website Snopes says, this explanation and similar ones are “long on fanciful theory and short on practicality”.

Nevertheless, it is a widespread practice which, if you want to understand the complexity of human interaction, it provides much food for thought. At first sight it is really rather mystifying. It adds complexity to what would otherwise be a simple economic transaction. Consumers generally like clear all-in prices, and the need to work out an appropriate level of tip is a further complication. Furthermore, if tipping is voluntary, you would expect rational consumers to pay as little as they can get away with — indeed nothing at all.

And yet, there are good economic advantages to the custom, argues Anthony Gill, a professor in Political Science at the University of Washington, in a paper from 2017. Gill sees tipping as an imaginative mechanism to solve three common economics problems: the principal-agent problem **, the capturing of gains from trade through price discrimination, and the establishment of cultural trust that is crucial for exchanges between strangers.

The principal and the agent

The waiting staff in a restaurant work for the manager or the owner — they are the agents working for the principal. Both share similar ambitions: lots of customers, who all go home happily (and hopefully will visit again). Yet, at the margin waiters and waitresses may prefer to take it a little easier, while their boss would rather see them work a bit harder. But of course, the manager has better things to do than constantly watch the staff to ensure they pull their weight.

If customers have the chance to tip, we can assume that they will reward good service more handsomely than mediocre service. So, diners can effectively become the mechanism to enforce quality service through incentives. In fact, the customers do not only take over some of the owner’s operational supervision of the waiting staff. They also help improve overall performance by ensuring that the best servers stay (by giving them big tips), and that the poorer ones either get better (so they too get more money) or leave.

There is no upfront contract though, so the customer holds all the cards. But experienced waiting staff will be skilful at spotting who is likely to appreciate superior service (and indeed what superior service means for individual patrons). As they hone their craft, they can ensure their attention and time goes to customers who will reward them after the event. The interests of all three parties are well served: the owner needs to worry less about the performance of the staff, the customers get what they pay for (or pay for what they get), and waiting staff can boost their earnings by delivering the right service.

A larger slice

Voluntary transactions make both parties better off. A restaurant owner sells the meal for more than the bare minimum she is prepared to accept, and customers buy it for less than the maximum they’d be prepared to pay (their reserve price). But if the price is fixed at such a level that it covers the full cost of the service, it may be above the reserve price of some customers, and leave tables empty. If the owner sets a lower fixed price to ensure every table of her establishment is occupied, she won’t be able to afford as many servers and the service quality, especially with more customers, will be lower. Moreover she will miss out because many of her customers would be willing to pay more.

Splitting the total price in a fixed portion for the food and a variable portion for the service can help avoid the deadweight loss of empty tables, because it attracts diners with a low reserve price and few expectations from the service. And those with a high reserve price can pay extra for better service.

In comparison with a fixed price arrangement, such price discrimination provides an advantage for all parties. The owner can reduce her fixed costs by lowering the wages of the waiting staff, and so lower the price of the meal and attract more customers. The servers will not only benefit from a fuller restaurant, but also from the fact that they can earn more than the average service cost by providing superior service to customers willing to pay for it. Together owner and staff obtain a larger slice of the gains from trade. And the diners who do value high quality service know waiting staff have an incentive to deliver it.

The missing ingredient

This is all very rational, but it still does not explain why people tip, and especially why they do so for example on foreign travels, when there is no future reputation to build or protect. Gill speaks of “thinly rational” people who would indeed enjoy a free ride, but believes most of us are “thickly rational”. We care about more than just the content of our wallet, and there are solid, rational reasons for this too.

Economic transactions benefit greatly from mutual trust between the parties, the confidence that the other side is not suddenly going to cheat us. Making a visible, voluntary sacrifice — like a tip — is an effective way of signalling our good and decent nature. Tipping is a pattern of behaviour that is consistent with care and attention for other parties in a transaction, way beyond narrow selfishness. So the entire society benefits from the custom of tipping, as it contributes to a larger collection of social norms that oil its wheels (much like other such customs, like holding doors open for strangers, do).

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I trust you, you sexy beast! (photo: Bradley Gordon BY CC)

This last justification of tipping on economic grounds stretches far into our human nature, though, and forms a good illustration of how economics and humanity are strongly intertwined. Perhaps it is not surprising that the father of Economics, Adam Smith, not only understood (and explained) very well why specialization and trade leaves everyone better off. He was also acutely aware of the deeper motivations of us humans. “Man naturally desires, not just to be loved, but to be lovely”, he wrote in the Theory of Moral Sentiments.

Maybe the economic constructs to defend tipping that Anthony Gill summarizes are simply a case of post-rationalization. Perhaps the most profound explanation why we tip is simply the fact that we wish to recognize others’ efforts on our behalf, because we want to be lovely people. That is a hard ideal to reach, but leaving a tip for the people who serve us is one small act that brings us a little closer.

Originally published at koenfucius.wordpress.com on May 18, 2018.

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Accidental behavioural economist in search of wisdom. Uses insights from (behavioural) economics in organization development. On Twitter as @koenfucius

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