The Operational, Economic, and Taylor Swift Drivers of Tipping
Last week there were some interesting surveys circulating about tipping.
Tipping, a traditionally ingrained practice in many societies, is lately under the lens of critical scrutiny. A Bankrate survey has recently revealed that 66% of Americans now have a negative view of tipping, a sentiment fueled by a perceived overreliance on gratuities and a barrage of tipping requests. Furthermore, the number of individuals who tip servers has dropped significantly, declining from 77% in 2019 to just 65% in 2023. As more Americans express disapproval of the culture of tipping, I think it’s important to understand what drives this behavior: both the one stated by people and the underlying forces that allowed this (admittedly odd) behavior to persist. Finally, I will try to explain why we see a decline.
Long-time readers of this newsletter know that it prides itself in promoting the idea (maybe believing is a better word) that everything has operational implications. In other words, every decision either impacts how firms operate, execute, and deliver value or is driven by how firms operate.
So not only will I try to explain tipping, I will try to understand its operational implications … and make Taylor Swift part of the explanation.
And I found it.
You’re probably thinking: There’s no way tipping has operational implications… and if it does, there’s no way Taylor Swift is part of it.
Wrong you are!
But let’s build toward that.
Why Do People Tip?
Tipping is a complex interplay of norms, pressures, and signals and varies significantly across cultures. There are many reasons why people tip:
“A survey in 2010 by Ofer Azar of Israel’s Ben-Gurion University of the Negev found that 85% of American tippers claimed to be following a social norm, while 60% said they tipped to avoid guilt.”
As an Israeli living in the U.S., I find this study fascinating.
A portion of this survey encompasses elements that are direct and easily understood: Tipping functions as a social agreement in which customers not only show gratitude for good service but also conform to expected social norms. However, a recent phenomenon known as the "tipping war" has emerged, introducing a new dynamic. This term refers to customers who tip more aggressively due to heightened social pressure, potentially leading to a cycle of excessive tipping and potentially inflating standard tipping rates.
Interestingly, amidst the discussion of these evolving norms, as the surveys above indicate, people are becoming less inclined to tip. This observation prompts us to question the underlying cause of tipping. If it primarily stems from social expectations, then why are we observing a decline?
To gain deeper insights into these distinct perspectives, let us further explore and attempt to comprehend the genuine root cause of this behavior.
The Psychological Aspects
Tipping clearly has some psychological foundations. For example, people sometimes tip when they're in a more cavalier mood:
“Ben said there were some bright spots. During the week of Taylor Swift's three-night run from March 31 to April 2 at the Dallas Cowboys' stadium, Ben said the city was in a great mood. 'Because people were happy at the concert, I was getting tips,' he said."
But there are also negative psychological aspects. For servers, while receiving tips can be perceived as the reinforcement of good behavior or service quality, which leads to improved motivation and performance, the uncertainty and inconsistency associated with tipping can contribute to anxiety. It can lead to an unpredictable income, resulting in chronic stress, impacting their overall mental and physical health.
For customers, it may cause psychological stress: the social obligation to tip and the pressure to figure out an appropriate amount can also cause psychological stress, especially when the customer is unsure about the customs or expectations.
As Michael Lynn, a consumer behavior professor at Cornell University, points out, the act of refusing to tip can generate discomfort, especially when it comes to electronic tip prompts. Simultaneously, customers may feel overwhelmed or confused about the increasing number of situations where tipping is expected, such as self-service kiosks and doctor's offices.
The Economic Perspective
Tipping traditionally serves as a significant portion of income for service workers like waitstaff and drivers. Yet, the diminishing culture of tipping poses a significant threat to these workers' earnings. With 18% of people admitting to tipping less or not at all when confronted with pre-set tip screens, a drop in overall gratuities is inevitable. This has potential implications for the labor market, especially given the current labor shortage in the service industry.
One reason people may be tipping less is the current financial situation. Inflation and the significant increase in prices may be prompting a number of people to question why they should tip. This is already noticeable in ride-sharing, where drivers report fewer tips.
From 2021 to 2022 (fiscal year), Uber experienced a 20% increase in the number of rides and delivery services, the while their gross bookings, which is the cumulative worth of fares and deliveries, not counting tips, saw a higher increase of 28%. The implication:
"I feel like the consumer goes, 'OK, gosh, I just took a 5-mile trip, cost me $25 on Uber or Lyft. I really don't have room to tip this poor guy,' he told Insider. 'In the old days, we used to get tipped more because the trips were so cheap, and people would throw $5 or whatever.'"
But when we say economic driver, we also ask whether there is a rational explanation for tipping, given that it’s done after the service is completed.
The first paper that really tried to understand whether tipping has an economic explanation was by Ofer Azar, who introduces a model where customers experience discomfort when their tipping behavior deviates from the socially accepted norm.
“The paper presents a model of the evolution of social norms. When a norm is costly to follow and people do not derive benefits from following it other than avoiding social disapproval, the norm erodes over time. Tip percentages, however, increased over the years, suggesting that people derive benefits from tipping including impressing others and improving their self-image as being generous and kind..”
Two interesting points: First, First, Azar’s findings suggest that without the positive satisfaction derived from tipping, the norm would gradually decay. So in order to sustain the social norm, a certain amount of psychological value must be derived from it. Second, the paper predicts that the tip % will increase over time. This was a prediction in 2004, which has held quite well.
But the main result is that psychological discomfort is needed for the norm to be sustained.
The Social-Operational Aspects
So is the main factor ultimately psychological?
Or can we explain tipping using solely a rational operational social model?
To have such an explanation, we need to be able to tie between tipping, service quality, and customer frequency. Studies indicate that repeat customers generally tip more than one-time or infrequent customers, and while not a research paper, the survey above shows that 16% tip to avoid poor service in the future.
Laurens Debo and Ran Snitkovsky study an operational model that tries to delve deeper into this question of the impact of tipping due to ensure “not getting poor service in the future,” and how it plays with social norms.
They study a scenario where customers tip after receiving a service. However, there's a distinction between two types of customers: repeat customers and one-time customers.
Repeat customers are individuals who frequently use the service. They have the ability to influence their waiting time through the size of their tip because the server recognizes them. Due to their regular visits, servers can predict how much these customers will tip. This is akin to tipping upfront, and the server can determine this tip as soon as these customers arrive.
On the other hand, one-time customers use the service only once or irregularly. They cannot influence their waiting time through their tips because servers can't predict their tipping habits. When such a customer arrives, the server forms an expectation about their potential tip.
In their model, to manage these customers, the service provider uses a priority system based on the size of the expected tip. The customers predicted to tip more are served first. If customers are expected to tip the same amount, they are served on a first-come, first-serve basis.
This model reminded me of the immortal Seinfled’s Chinese Restaurant episode:
“Jerry: Excuse me... we've been waiting here. Now, I KNOW we were ahead of that guy, he just came in.
Bruce: Oh no, Mr. Cohen always here.
Elaine: He's always here? What does that mean? What does that mean?
Bruce: Oh, Mr. Cohen, very nice man. He live on Park Avenue.”
“In the absence of a social norm, one-time customers do not tip. They only join when repeat customers join (GA: the queue) too, and the potential market of the latter is relatively small. Thus, as in the tipping literature, in our model, rational one-time customers are not motivated to tip in the absence of a social norm.”
“In the presence of a social norm, one-time customers do not necessarily tip when they join. Contrary to the tipping literature (with an exogenous social norm), the existence of a social norm is not sufficient to motivate one-time customers to tip. Only when the service value is high enough and the potential market of repeat customers is neither too high nor too low, there exists an equilibrium in which one-time customers tip. When they tip, all repeat customers also join (and tip also).”
Basically, the social norm is essential but not sufficient if we believe that the server is rational (in making decisions on who to treat better or worse) and the customers know that.
When the Plan Backfires
The surge in requests for tips, often solicited in close proximity to employees, has only added to this social pressure. This "guilt tipping," as coined by Kelly Goldsmith, a Vanderbilt University marketing professor and former Kellogg colleague, can turn an act of appreciation into an obligation, creating discomfort for both employees and customers.
One of the main results from the paper above is that tipping doesn’t really happen in the absence of a certain social norm and repeat interaction, which are two characteristics of the ride-hailing world:
"Consumers have been trained, basically, not to tip when it comes to rideshare," he said. "But I think it should be the opposite way around. When was the last time you were in a cab, you got out without a tip? So to me, rideshare drivers are getting stiffed on this deal."
We see that to maintain operational drivers (i.e., tipping to avoid receiving bad service in the future), a social norm of tipping must be prevalent. To maintain the social norm, there must be some psychological benefit —the feeling of "when I tip higher than other people, I get a warm glow," for instance. But we also see that if people only have one-time transactions, even with the social norm, they may not tip. So as we interact with service providers through platforms (where norms are still evolving), more of our transactions will be one-time transactions. Furthermore, as restaurants and coffee places put higher and higher tipping amounts as default on their screens, we will get less of the warm glow effect and more of the discomfort of the psychological burden that comes with tipping, undermining the main driver underlining even the social norm.
So will tipping stop? Not so quickly.
Despite its increasingly negative perception, the culture of tipping in the service industry is rooted in social pressure and, in some cases, the consumer's desire to appear generous. Yet, the societal and economic implications of tipping reveal a practice in flux, one caught between evolving social norms and economic realities. My prediction is that as the world becomes more gigiified, and thus more alienated, we are more likely to see less tipping.
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