The end of tipping: How both sides of the argument have it all wrong

The right incentive?
The right incentive?
Image: Reuters/Ints Kalnins
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If there is one thing we learned from restaurateur Danny Meyer’s no tipping announcement last week it’s that discretionary pay is as uniquely American and divisive as the right to bear arms. Anti-tipping advocates were quick to point to Asia and Europe where tipping is less common, though so is indifferent service. Pro-tippers argue it better aligns incentives and makes customers feel good. But both sides of the tipping argument have it all wrong.

What those in favor of tipping get wrong

Pro-tippers think Meyers move is anti-market because customers lose the power to pay for quality of service they receive. There is evidence that tipping does result in slightly better service. It may be better for servers and customers, but it is terrible for everyone else in the restaurant industry. The current system is actually less market-oriented because a large share of the revenue must go directly to the server and not to the owner. In a normal market the owner would allocate revenue among his employees based on their value and the scarcity of their skills. When you go to a restaurant, you pay for food and service, each provided by the restaurant. But tipping means you pay for service directly to the waiter, even though she’s employed by the restaurant and other restaurant staff contribute to your service experience, but aren’t compensated for it.

There is evidence tipping is creating a market distortion. According to Eric Blinderman, owner of restaurants Mas Farmhouse and Almanac, chefs—who require years of training and considerable skills—are paid a fraction of what waiters get after tips. He estimates servers in fine dining restaurants may make between $100,000 to $150,000 a year; while a chef de cuisine may only make $50,000; line cooks earn considerably less—as little at $20,000 a year. Blinderman can’t correct this imbalance by simply paying chefs more because his margins are too thin, customers are too price sensitive, and he has no control over how a large share of his revenue is allocated. The pay disparity has created a chef shortage and Blinderman observes much higher turnover in chefs compared to wait staff. The evidence suggests the tipping system, combined with regulation on how tips can’t be redistributed to other staff members, results in servers (of high-end restaurants) being overpaid and chefs underpaid.

And it’s about to get worse. Blinderman says the higher minimum wage for tipped workers in New York City (about to increase from $5 to $7.50) will exacerbate the distortion and leave less money for chefs—who already are paid above (but not by much) the minimum wage. He says restaurant owners have been itching to do what Meyers is doing for years. But lowering the pay of servers will make it harder to retain talent, though it could mean a more stable, better cooking staff. He speculates the minimum wage legislation may be the tipping point that will force high-end restaurants to consider a different model. (Meyers claims this wasn’t his motivation.)

What those against tipping get wrong

Anti-tippers argue salaries, instead of tips, will be better for servers because they think there is something unseemly about accepting tips; earning a salary is more dignified; tips don’t improve service; and that a higher, predictable salary would be better for servers. A salary could make servers at some restaurants better off, but at high-end or very busy places, it probably won’t. Meyer plans take what used to be the tip, soon to be a service charge, and add it to other revenue and pay his employees more equitably. Meyer will pay servers a lower salary than other employees. But they will participate in a revenue sharing plan which he claims, most of the time, will yield similar pay. Perhaps it will work if there’s extra revenue to go around. But it’s hard to see how that would work at most restaurants. Even if prices go up 30% (owners also have to pay tax on the salaries) there’s not much new revenue. Restaurants, even high end ones, tend to operate on thin margins. The goal is correcting a pay imbalance, which may be a better market outcome but it does make at least one party worse off—previously overpaid waiters.

Considering chefs have years of school, training and skill it does seem like a market distortion they are paid so much less than waiters. But while the pay disparity is particularly bad in the restaurants, to some degree it is something workers in all industries face. Servers are essentially the sales people in a restaurant. In most industries (media, finance, manufacturing), the sales people are often not the best educated or smartest, but they also are often the best compensated—often with higher, variable performance-based pay. What office worker hasn’t felt resentful that a less educated, less intelligent, but exceedingly charming sales person makes much more than he does—for selling the product his talent produced?

Tipping does have some benefits, but a move away from it is in many ways a victory for back office talent everywhere.