Nov 09, 2022

Why Is Tipping Everywhere You Checkout?

Keeping posted prices low while offering a path for customers to pay more is the best way to give a raise for both the employer and employee.

You see it at your coffeeshop, smoothie place, virtually every food offering where you insert, swipe, or tap. The question from many is why are we constantly asked to tip? Why can't the business just pay them more?

The answer is simple yet hidden hidden. First, here's a coffee shop owner highlighting the starting dynamics...

The top comment on this Tweet thread was "How about just raising the prices 10-15%?".  My answer was the top response, here it is laid out better than I did on Twitter...

If a coffeeshop wants to pay their employees more they will have to raise prices. This makes them less competitive to any nearby coffeeshops that haven't raised prices.

Most consumers are price sensitive so it would be a gamble for a coffee shop to raises prices. What if all the shops nearby maintain a lower price? A loss of volume could easily swamp the amount of money gained from a higher per coffee price. Is the coffee really that much better to justify a higher price? As a commodity item, probably not.

Instead, if you give price insensitive buyers of coffee (rich people) the ability to pay more for the coffee they want (ask them to tip at the end), the extra money can go straight to the employee (a de facto raise) and the coffee shop doesn't have to advertise higher prices.

In effect, the coffeeshop maintains its lower prices while incentivizing employees to stay for higher wages because people do end up tipping.

From a game theoretical standpoint in a crowded field (coffee shops) where everyone is doing it, keeping posted prices low while offering a path for customers to pay more is the best way to give a raise for both the employer and employee. Otherwise, if the business raises prices and customers leave the business may shut down, leaving the employee without a job.

And because coffee shops aren't forced to have this same checkout experience each will naturally end up on this same path to a digital tipping screen to avoid going out of business, losing employees, or both. In fact this is a fairly efficient way to lower what's called "consumer surplus". Consumer surplus occurs when a person who is willing to pay more is charged less than the amount they're willing to pay.

Tom is willing to pay $6 for coffee and the shop only charges him $4, the consumer surplus in this instance is $2.

If you have the ability to charge more, exclusively to those that are willing to pay for more (ask them to tip), while charging less to those who aren't willing to pay more you can eliminate at least some aggregate consumer surplus.

The cost of eliminating a bit of consumer surplus might be in making some people feel awkward or shame when they get to the tip screen.

This blog post is also available on our YouTube channel...

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