Wednesday, 24 May 2017

Three reasons why tipping is a bad idea

Tipping has been in the news this week. Matt Heath started it with this article on Sunday, but then Deputy Prime Minister (and former waitress) Paula Bennett chimed in, saying "Overall I think the service in New Zealand is good, I always tip for excellent service and encourage others to too if we want standards to continue to improve" (at least, according to this article - I didn't read her letter to the Herald myself). Bennett's comments have stirred a lot of media interest (see here and here and here, for example). Now, as the voice of reason, I give you three reasons why tipping is a bad idea.

First, it's not rational if it's not already a social convention. To see why, we need to go through a little bit of game theory (which is good revision for my ECON100 students, since we did game theory in class last week). Consider a sequential game with two players: (1) the server, who can choose to give average service, or good service; and (2) the customer, who can choose to tip, or not, and makes their choice after the service decision of the server has already been revealed. Let's say that the basic outcome (average service and no tip) leads to a zero payoff for both players. Let's also assume that if the server gives good service, that increases the payoff to the customer by +6 (units of utility, or satisfaction), but comes at a cost to the server of -2 (units of utility). Finally, let's assume that if the customer chooses to tip, that reduces their payoff by 5, and increases the server's payoff by 5. The game is laid out in tree form (extensive form) below.

To find the subgame perfect Nash equilibrium here, we can use backward induction (similar to the best response method we use in a simultaneous game). Essentially, we work out what the second player (the customer) will do first, and then use that to work out what the first player (the server) will do. In this case, if the server gives good service, then we are moving down the left branch of the tree. The best option for the customer in that case is not to tip (since a payoff of +6 is better than a payoff of +1). So, the server knows that if they give good service, the customer is better off not tipping. Now, if the server gives average service, then we are moving down the right branch of the tree. The best option for the customer in that case is not to tip (since a payoff of 0 is better than a payoff of -5). So, the server knows that if they give average service, the customer is better off not tipping. Notice that the customer is better off not tipping no matter what the server does - not tipping is a dominant strategy for the customer. So, the choice for the server is to give good service (and receive a payoff of -2) or to give average service (and receive a payoff of 0). Of course, they will give average service. The subgame perfect Nash equilibrium here is that the server gives average service, and the customer doesn't leave a tip.

However, that analysis assumes that this is a non-repeated game. We know that if games are repeated, the outcome may be able to move away from the Nash equilibrium to an outcome that is better for all players (notice that the combination of good service and tipping is better for both players). How do we get to this alternative outcome? It relies on cooperation between the two players, and cooperation requires trust. The server has to trust that the customer will tip them, before they will agree to give good service. Can they trust the customer? Only if they have developed a relationship with that customer, and in most hospitality situations it is unlikely that a customer will encounter the same server again in the future (unless they are a regular). So, no trust. No cooperation. No tipping, and no good service.

Which brings me to social convention. One way to ensure cooperation from the customer is to make tipping a social convention, which has some social penalty attached to it. If it is frowned upon not to tip the server, to the extent that it becomes costly (in terms of moral costs or social costs, not financial costs) not to tip, then that changes the game. Say that the moral cost of not tipping is -6 units to the customer (since everyone who sees them not tipping the server then thinks the customer is a douchebag). This changes the game to this:

Now, where is the subgame perfect Nash equilibrium? If the server gives good service, the customer will tip (because +1 is better than 0). If the server gives average service, the customer will tip (because -5 is better than -6). Notice that tipping is now a dominant strategy for the customer. Knowing what the customer will do, the server will choose to give good service (since +3 is better than 0). The subgame perfect Nash equilibrium is now that the server gives good service, and the customer leaves a tip.

But it relies on a social convention, which is not the current convention in New Zealand. And developing new social conventions is not easy (although perhaps Paula Bennett is willing to give it a try in this case?).

The second reason why tipping is a bad idea is because of second-order effects. If customers have to tip the servers, this increases the cost of their meal. Since we know that demand curves are downward sloping, an increase in price will lead to lower quantity demanded - customers will demand fewer restaurant meals. If you doubt this point, then consider how many people you know (I'm sure there are at least some) who object to paying a surcharge for a meal on a public holiday, and so choose to either eat somewhere else (where there is no surcharge) or not to go out at all. Now, note that tipping is essentially the same as applying a surcharge to every restaurant meal.

Since the quantity of restaurant meals demanded will decrease, the number of servers required by restaurants also decreases. Tipping will make some servers better off (higher take-home pay), but will make others worse off (they no longer have a job). This has the same effect as raising the minimum wage, except the customers are paying the extra, rather than the employers. I'm not sure that's a trade-off that customers should be willing to accept.

The third reason why tipping is a bad idea is because it could be considered a form of corruption. If you doubt that, consider this example. Remember that the purpose of tipping is to reward the recipient for giving good service. Now, say that I'm pulled over by a police officer for driving through a stop sign, but the officer decides to let me off with a warning (seems unlikely, but let's run with it). The officer gave me good service - should I tip them?

The World Bank defines corruption as:
...the offering, giving, receiving or soliciting, directly or indirectly, anything of value to influence improperly the actions of another party.
Isn't tipping to reward good service providing something of value (money) to influence the actions of another party (to give you good service)? We could quibble over whether the influence is improper or not, I guess. But the general point is valid.

Anyway, now you have three reasons to use to explain why you shouldn't be tipping: (1) it's not rational (when there is no social convention for tipping); (2) it may make some servers worse off; and (3) it may be corrupt. You're welcome.

5 comments:

1. There's also substantial research showing how minorities receive lower tips. Reason 4: It is discriminatory.

1. I'm not familiar with the research, but that wouldn't surprise me one bit.

2. To be fair, the first argument comes down to the assumptions you plug into the model. One could argue that giving good service isn't actually a cost to the server at all.

1. Even if you removed the assumption that it is costly to the server (and even if you made good service better than average service for the server), the customer would still have a dominant strategy not to tip (in the absence of a social convention of tipping).

3. Great illustration of Game Theory!!