Tipping, Fair Pay, and FairPay

Tipping in restaurants made the news this week, raising many questions about "fair pay" the social movement toward fair wages -- but also bearing on the very different issues of "FaiPay" the new strategy for value-based consumer pricing described on this blog (and outlined on the Harvard Business Review Blog).

The news is that the prominent NYC-based Union Square restaurant group is phasing out tipping entirely in most of its restaurants (Union Square Cafe, Gramercy Tavern, The Modern, ...). This is a very complex issue, as noted in the NY Times article on 10/15/15, including issues of customer service, fair wages for labor (the "fair pay" issue), economic policy (do minimum wages apply to tipped workers) and even tax policies.

As described in other posts and the sidebar, FairPay is a strategy for setting prices with user participation, having elements of pay what you want (PWYW) that are much like tipping.

• What FairPay adds to PWYW is that it is applied in the context of a relationship that continues only as long as the payments are considered fair by the business. Thus the consumer can pay any price they want for a given transaction, but the business can decide to stop offering FairPay transactions to a consumer who they consider to be free-riding. That gives the consumer strong reason to pay fairly, to maintain that privileged relationship.

• This works very much like restaurant tipping -- especially in the case of diners who might be regulars at a given restaurant, and thus concerned about their reputation for tipping fairly, and how that affects their ongoing relationship with their servers (who may provide less service to those they feel were unfair, and superior service to those who are generous). So the behavioral economics of tipping, and of PWYW, are very relevant to FairPay.

My focus here is not on the complex issues of wage equity in restaurants, but on the behavioral economics of the FairPay model -- as applied to other kinds of value exchange -- how tipping sheds light on broader issues of customer value propositions. Still more broadly, these are questions of the overall effectiveness of how businesses relate to their customers, and the processes for determining how value is shared among consumers, businesses, and workers.

Price=Value

The essence of FairPay is the idea that price should correspond to value -- as actually experienced by the customer in the full context of that experience, as it evolves over the course of the relationship. It is based on open dialog and transparency about the value exchange, the costs, and the economic value surplus that is "co-created." If the parties behave fairly, this lead to economically optimal pricing that produces the greatest overall value for all. The details all have to do with getting that fair behavior.

The Times article on tipping makes some interesting points. One is very supportive of this core benefit, an agreed to value exchange that is win-win for both sides:

Many customers remain deeply attached to the right to reward attentive service, or to withhold that reward. And servers often say that the bonanzas they take home after busy nights far outweigh the risk of getting nothing once in a while.

It is widely recognized that when restaurant service is built into prices, with no discretionary reward for service quality, quality is often poor and customers dissatisfied. There are of course some customers who tip unfairly (or not at all), and depending on the demographics of the clientele, this may or may not be a serious problem. But presumably the problem decreases among regular customers, and it is in just such long term relationship contexts that FairPay seems most likely to do well (and I suggest that its use be limited to such contexts). Just to reinforce the key points, I repeat that quote, with added emphasis:

Many customers remain deeply attached to the right to reward attentive service, or to withhold that reward. And servers often say that the bonanzas they take home after busy nights far outweigh the risk of getting nothing once in a while.

Better for both parties!

Clarity and transparency

As always, the devil is in the details, and there is much complexity here. Some of that relates to clarity and transparency as to who is being compensated for what. Another quote:

By increasing prices and ending tips, Mr. Meyer said he hoped to be able to raise pay for junior dining room managers and for cooks, dishwashers and other kitchen workers. Compensation would remain roughly the same for servers, who currently get most of their income from tips. Under federal labor laws, pooled tips can be distributed only to customer service workers who typically receive gratuities, and cannot be shared with the kitchen staff or managers.

Much of that was news to me, in spite of having tipped in NYC restaurants many hundreds of times over many decades. My impression was that it was the servers who got the tips, not the kitchen staff (but I was not sure if that was always true), but I still have no clarity on whether my tip goes to my waiter alone, to all waiters, or to other service staff (which I presume varies with the restaurant). Makes it hard to know what is fair doesn't it? Without knowing who my tip goes to, it is hard to be fair. But if I know what goes to my server, I have a pretty good sense of the fairness of that (as long as I am cognizant of the common "reference price" that 20% is fair for a normal level of good service).

Another aspect of transparency is that the "dialog" about value in a restaurant is very limited. There is the service and the tip, and maybe some polite chatter or body language, but that is about all. It is rare that either party communicates specifics as to why a given tip might be fair or not.  FairPay suggests that convergence on a mutually desirable exchange will be most effective with clear dialog on what is or is not working with all aspects of the value proposition. That may well be awkward with a restaurant server, but it can be very direct with a business that uses modern computer-mediated dialog services such as feedback forms, and that invites and responds to such dialog.

So the NYC restaurant issue involves many factors not directly relevant to FairPay as it applies to other industries -- such as service versus kitchen staff and wage and tax laws -- but the essence seems to reinforce evidence from studies of PWYW in other contexts that people do pay fairly when given clear information on what they are paying for and why. It seems the problem with tipping is not that it doesn't work well for servers, but that other workers are not doing as well. The article goes on:

“The gap between what the kitchen and dining room workers make has grown by leaps and bounds,” Mr. Meyer said. During his 30 years in the business, he said, “kitchen income has gone up no more than 25 percent. Meanwhile, dining room pay has gone up 200 percent.”

This begs the question of why take tipping away from those it works for? Tipped workers were clearly much better served than non-tipped workers. (As a reference point, the CPI increased 221% in the past 30 years.) Again, my issue is not whether tipping is good labor practice, but what this tells us about pricing models more broadly. It may well be that tipping is less effective in less high-quality, service-oriented restaurants (or where waitstaff may be at risk for abuse by customers or management). But it is those contexts where quality and service are key elements of the value proposition that I suggest are the prime opportunities for FairPay.

Computing value

Another thing that tipping teaches about FairPay is how easy it is for people to compute value intuitively. On hearing about FairPay in other contexts, such as for digital content subscriptions, people often ask "isn't it a difficult cognitive burden for customers to have to think about the value?"

But tipping provides a clear answer -- this computation is not difficult -- it is highly intuitive. We easily do a complex multivariate, multi-dimensional analysis in our head, during and after a meal and know immediately whether we think the service was average, or better or worse, and by roughly what degree. We can then easily figure whether we adjust our average tipping level up or down, and whether to adjust for being a regular or any other special factors, to conclude that we should tip X%. Any computational difficulty is just doing the arithmetic of how much X% of the bill is (with or without tax, rounding, etc.). Other complications relate to whether our tipping is visible to others in our party that we might want to impress -- which is something that may or may not be relevant in FairPay contexts, and may not be much of a problem even when it is a factor.

So all in all, it seems the behavioral economics of tipping is very supportive of the idea that FairPay will prove very effective in selected business contexts. Whether tipping can and should survive in restaurants -- given all of the unique social, labor, and legal issues involved -- is a different question.