Automated Tipping and Price Discrimination

Who gets the money when you tip?

When online bill payment processors first started including recommended tip amounts researchers were happy to study the impact. By changing the recommended tip amounts (in dollars or percentage) they could quantify the impact on the amount consumers tipped. Some studies even looked at the downstream impact on consumer satisfaction with the entire buying experience.

Generally the studies found that higher “recommended” amounts lead to higher average tips (one example). And, at least within the range of 5%-25% recommendations, higher recommendations did NOT lead to reduced consumer satisfaction.

Given that data, the rational choice for companies was to recommend higher and higher amounts. It resulted in more pay for their employees with no (measurable) negative impacts.

As employees make more money with tips it gives employers flexibility to decrease pay. I imagine this would never be done directly — an individual employee is not going to have their hourly wage reduced — but it will be done over time indirectly. Employees that are making more per hour with tips can receive smaller (or no) raises. New employees can be brought on at lower rates, with the understanding they will make it up in tips.

How many times have you heard, “It is important to to your wait staff. They don’t make a living wage without it.” The statement is true! But the reason they are not paid a higher wage is because, on average, they receive compensation in tips.

Tips are effectively a way to practice price discrimination on customers. Price sensitive customers can choose to not give any tip at all. But customers who are willing to pay more are given an opportunity to do so — as well as the satisfaction that their increased payments will go directly to an individual rather than a faceless corporation.

Price Discrimination

When Uber launched, part of the pitch was that the price you saw was the price you paid. There was no need for the tipping that was required when you took a taxi (and/or the unpleasantness when an individual driver did not get the tip he thought he deserved [Side story: I was once in a taxi that rear-ended a car in front of us. We had to call a separate cab, as well as wait for the police to give our statement. The driver was upset when we did not give him the tip he thought he deserved. I thought he was lucky to get anything at all]).

Lyft differentiated itself from Uber by allowing users to tip (the “benefit” was largely a way to poach drivers from Uber. I expect most users were not switching apps for the feature). Mid-way through Uber’s “no good, very bad year” in June 2017, the company added the ability to tip drivers. While it was never required to tip (is it required anywhere?), it created the perception that others were tipping and that a tip was part of the new social contract. But studies have found that old habits die hard. Only 1% of riders always tip, 60% rarely or never tip, and drivers receive tips on only 16% of rides. But that is 16% more than they were getting before. Unsurprisingly over the last six years Uber has taken a higher and higher share of the base payment charged to the user.

Over the long run, creating a tipping expectation does not increase employee pay, it just increases industry and company price discrimination, which extracts more dollars from the least price sensitive consumers and, eventually, increases companies profit and return on capital.

But if companies are more profitable as a group, then, at least in retail, landlords will be able to charge more. So perhaps the ultimate winner of self-checkout tools which prompt high tips will be the ultimate landlords: airports. From the WSJ:

Prompts to leave 20% at self-checkout machines at airports, stadiums, cookie shops and cafes across the country are rankling consumers already inundated by the proliferation of tip screens. Business owners say the automated cues can significantly increase gratuities and boost staff pay. But the unmanned prompts are leading more customers to question what, exactly, the tips are for. “They’re cutting labor costs by doing self-checkout. So what’s the point of asking for a tip? And where is it going?”… “Just the prompt in general is a bit of emotional blackmail,”

Generally it IS going to the employees:

Employers are legally obligated to give tips to workers. Restaurants and other businesses have faced lawsuits over their distribution practices over the years.

Some tipping researchers say that tips given to a machine may not reach human employees, because protections to tipped workers in the federal Fair Labor Standards Act don’t extend to machines…

An OTG spokesman says that all money collected as a tip is paid out to employees, and that tips at self-checkout machines are pooled among staff working that shift… A Crumbl spokeswoman confirms that both employee and customer kiosks provide a tipping prompt upon checkout and that tips are distributed among bakers in accordance with federal, state and local labor laws.

It may be possible that some of the tip “donations” do not go to employees, but that seems unlikely and not worth the risk for most employers. Especially given that as norms change and average tips generated per hour at the kiosks increase, employers can just reduce new salaries. Given employee turn-over rates in retail employers will not be out the cash for long.

And while the WSJ found lots of anecdotes of consumers being annoyed at the “emotional blackmail”, the prompts seem to be working:

Square, whose technology powers many iPad point-of-sale machines, says tipped transactions were up 17% year-over-year at full-service restaurants and 16% at quick-service restaurants in the fourth quarter of 2022…

Chaia co-founder Bettina Stern says tips on the self-serve kiosks are “a way of acknowledging all our employees do to provide a hospitable environment.” Tips increased significantly after installing the machines…

So should you tip in these new environments?

Probably not.

If you want to reward individual employees you are likely best to pay them cash directly. The money will be guaranteed to go to the individual, and it is less likely to drive down future wages.

But if you are a company considering adding a “suggested tip” to your kiosk, then the data says you likely should. I just worry that it is causing some long term negative effect that we have not yet been able to measure.

Keep it simple,

Edward

p.s., In tomorrow’s subscriber-only post I will expand on this topic and how it relates to B2B vendor negotiations. Subscriber below so you don’t miss it: