How Americans Can Tame Their Tipping Craze

Dear Friends,

Before we dive into the controversial topic of tipping, I’d like to provide a quick update on recent and upcoming speaking appearances.

For a wide-ranging discussion that goes beyond prices, you can listen to a recent episode of BCG’s “The So What” podcast, where I talk about the seven pricing games and why it’s important for companies to establish their pricing strategy first. You can click HERE for the podcast or find it via your favorite app.

Next week, the road show for Game Changer and the Strategic Pricing Hexagon continues when I conduct a breakout session on Thursday, November 9th at the 17th EPP Global Pricing Forum 2023 in Brussels.

Tipping isn’t a big deal in most of the world, but it is a seemingly intractable cultural norm in the United States. The long history of tipping in the United States – as this short animated video shows - has established an awkward equilibrium that binds restaurant owners, their service staff, and their customers together.

Tipping has evolved from a private decision – an amount scribbled discreetly on restaurant receipts or left behind as cash – to a common request in many service sectors, often facilitated via electronic devices with many eyes watching. The Wall Street Journal has called out the growing spread of tipping requests and noted that the way customers respond usually "hinges on gratitude or guilt." But confusion reigns. An article in the New York Times notes, for example, that there is “no collective understanding of what we owe delivery drivers in tips.”

In this issue, my co-author Arnab Sinha and I, reframe tipping as a pricing challenge and explore how groundbreaking changes – such as a proposed new law in Chicago – can alter that awkward equilibrium in ways that allow all parties to win.

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How Americans Can Tame Their Tipping Craze

The city of Chicago, home to 2.7 million people and 7,300 restaurants, is on the verge of eliminating the long-standing practice of tips-as-wage. A new law would gradually increase the minimum wage for restaurant staff over a five-year period from $9.00 per hour to $15.80 per hour.

The adjustments that service staff, customers, and restaurant owners make in response to the new law will determine whether these kinds of laws lead to long-term wins for businesses and society. But before we explore specific solutions, it is worthwhile to look briefly at the evolution of tipping and show how basic pricing frameworks – the interactions between cost, value, and competition – expose the different opportunities that each party has.

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The evolution of tipping in the United States

Tipping as we know it began in the late 1800’s when Pullman porters and other service providers received their wages – either entirely or partially – from the customers they served rather than from their employers. Over time, social norms led to tipping converging around the magic number of 15% on top of the meal price, cab ride, or other service.

The practice of tipping 15% or more is culturally entrenched in the United States and other countries in the Americas, but it is far less common in continental Europe. The Japanese may even consider a tip to be an insult. ?

This convergence to a 15% standard has created the awkward equilibrium we mentioned above. Tipping allows restauranteurs to keep prices artificially low, because low minimum wages for service staff gives them more flexibility to set profitable prices. That’s because tipping transfers labor costs from employers to customers, meaning that service staff depends on the generosity of customers to earn a living wage.

But this tradition subjects service staff to biases. Tip amounts often depend on gender, race, or other factors beyond the quality of service and can give rise to accusations of sexual harassment. A lower base pay for service staff also increases the risk that they live below the poverty line. An analysis by WBEZ, the Chicago public broadcasting affiliate, showed that more than half of the metro area’s 85,000 bartenders, waiters and waitresses earned less than $15.00 per hour before tips. Their poverty rate was 24% versus 10% for bartenders and wait staff earning $15.00 per hour or more in base pay.

Tipping is also awkward for customers. The discretion of customers may make tipping seem value-based, but at its core it helps service staff cover their own costs. According to a study reported by The Economist, 85% of Americans claimed they follow social norms when they tip, while over 60% do so because service staff depends on tips. Between 40% and 60% of Americans tip to avoid feelings of guilt or embarrassment.

The latest stress on this equilibrium comes from the growing use of touchscreen payment platforms with options for tipping. Instead of doing mental math in private, customers now pick a preset option – say 15%, 20%, or 25% - often in direct view of the service provider and other patrons. This can generate more tip revenue. When taxicabs in New York City began to accept credit card transactions over a decade ago, the average tip rose to 22% versus 10% when riders paid in cash.

An opportunity for a better equilibrium

The wage change in Chicago will alter the awkward equilibrium, because it shifts the emphasis from cost to value. Ideally, new laws like the one in Chicago, would lead to three outcomes:

• Service staff can earn a living wage that exposes them to less risk of bias and harassment. This is an example of how pricing – in this case, in the form of wages – can reshape society in a positive way.
• Customers can reward service staff based on the value they provide, not based on guilt or a perceived obligation to cover their living expenses.
• Restauranteurs can remain profitable by changing their pricing game instead of simply passing along higher labor costs in the form of surcharges or higher menu prices.

This would bring the US structure more in line with Europe’s, where customers leave behind a nominal amount as a tip, often by rounding up the bill. The names of these tips – Trinkgeld in Germany and pourboire in France – imply that the extra money is “drinking money” rather than a way to help service staff earn a living wage.

But let’s get back to the United States. The lenses of costs, value, and competition – and their interactions – reveal the agency that each party has to shape this new equilibrium. Let’s start with service staff. In its 2023 State of the Restaurant Industry report, the National Restaurant Association said that 62% of restaurants report being understaffed. The floor of the new minimum wage can give service staff greater bargaining power – individually and collectively – as they decide where to work and understaffing persists. This is also an opportunity for service staff and employers to work out the best employee incentives at the individual and team levels.

Customers, meanwhile, can reward service staff and restaurants based on value. The amount of any gratuity can now reflect the customer’s willingness and ability to pay, not their perceived social obligation to help cover the costs of service staff. Rewards can also come in non-monetary forms, such as online reviews.

Restauranteurs should avoid the temptation to add fixed surcharges or make blanket price increases on their menus. Instead, two factors should guide their thinking on menu changes. First, the risk of losing business due to higher prices is smaller than expected, because the law in Chicago creates a level playing field for all restaurants. Second, the new emphasis on value in the industry – combined with the need for all competitors to respond – creates the conditions for the Choice Game, which we described in a previous edition of our newsletter.

The seven games of the Strategic Pricing Hexagon, which we describe in our book Game Changer, apply to all businesses, even individually owned small businesses such as many restaurants. Menus are fertile ground for behavioral approaches – especially anchoring, decoys, and the compromise effect – that guide customers to options that are more profitable for the restaurant. The use of these approaches is one key success factor in the Choice Game. It means that the overall relationship among prices on the menu is more important than the optimization or maximization of any individual price.

Game Changer ranked on the bestseller lists of USAToday and The Wall Street Journal last week. You can order a copy HERE.

Please continue to share your thoughts and questions with us. Thanks for your interest and support!

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