To tip or not to tip and the dilemma of a service charge

What exactly is the matter? We routinely pay an add-on over listed price for several services, voluntarily or prompted. It can be a service charge included in some restaurant bills or an online cue to “add a tip" for a food delivery agent or cab driver. Alternatively, as per a long-standing tradition, some firms leave it to customers to tip workers directly.

Why do firms adopt different practices when the basic idea is the same: customers should acknowledge good service which also allows low-skilled workers make extra money over and above their low wages?

If people use a service repeatedly from the same firm, say a hairdresser, a tip is also seen as ensuring continued service quality. Sometimes, we pay a tip out of social norms or guilt, even if the service is not good. Tipping norms differ worldwide from around 5% to 25%.

How does a service charge that some eateries add by default to our bill differ from the traditional form of tipping? We are free to pay a tip in cash to a server, but a service charge generates revenue, which the management has control over. Managers can decide how to distribute the intake among employees. In contrast, in case of a tip, a firm’s management has no right to ask either party, the worker or customer.

Typically, service charge collections are distributed among customer-facing employees like servers as well as backroom workers such as cleaners and cooks. When we pay a tip, it goes only to the person who serves us. While service charges may benefit more workers, there is a catch.

First, no one really knows how much of the service charge pooled from customers is passed on to the staff. In recent years, there have been reports of restaurant owners not passing on the entire amount. In response, the income tax department had clarified that firms are liable to pay income tax on service charge collections not distributed to workers. Second, because service charge collection is divided among several workers, the intended beneficiaries of a tip make less than what they would if tips were paid directly.

Third, it lets firms keep workers’ wages to a bare minimum while luring them into jobs by guaranteeing additional cash. As wages do not have to be increased, a service charge also helps firms keep product prices lower. This way, firms avoid an adverse impact on demand and profits, while retaining workers.

People order food based on prices listed on menu cards. When the bill arrives, people typically go by the default or status quo bias: If it needs a blank filled for “service charge," they miss doing so, and if it slaps on a service charge, they pay up. Many of us display a cognitive tendency to prefer the existing state of affairs rather than make an active choice. Some people may not want to come across as rude, especially in a social setting. So printed service charges end up taking the form of automated tipping.

To make it easier for customers to decide whether and how much to pay as a service charge, restaurants ought to inform their customers while presenting the bill that this charge is optional. However, many do not follow this practice. Some people pay service charges, and, at times, an additional tip.

The Delhi high court fined a restaurant organization for non-compliance of its earlier directives. It directed restaurants to replace the term “service charge" with “staff contribution" and specify on their menus in bold that tips need not be given after a staff contribution is paid. It remains to be seen if restaurants comply with this directive.

How do taxi service or food delivery firms manage customers’ tipping behaviour? The experience of Swiggy shows that during the pandemic, a higher proportion of customers were happy to pay a tip, in addition to the delivery charge, when placing orders. Empathy for delivery personnel drove customer behaviour during covid. This proportion fell post-pandemic, once customers reverted to their basic trait of wanting a satisfactory experience before paying a tip.

Swiggy experimented with prompting customers to pay tips after the delivery, when feedback is collected. Since then, however, they have reverted to the original model of asking for a tip when placing the order, perhaps because not enough people are inclined to return to the app or website to provide feedback each time.

What should customers do? Sometimes being traditional makes sense: Just pay a tip (and generous one) directly to those you wish to show appreciation towards. It encourages good service and reaches its intended beneficiaries, whether restaurant servers, delivery personnel, hairdressers, cab drivers or housekeeping staff.

Should customer worry about the service charge or staff contribution? Pay if you are price insensitive and are not worried about how much of it is passed on to workers. Else, ask the staff if they get a share, then decide to leave it, ask the establishment to lower it, or scratch it off altogether as a payable.

If there is a shortage of backroom workers, firms must pay them more directly to retain their services. In turn, firms should raise their prices or settle for lower profits. That is up to them to decide.

Both customers and firms have a choice which they should exercise.