The Case for a Service Charge

I’ve had frequent discussions on the emerging trend to get rid of tipping.   Many people whose opinion I respect argue that the best approach is to simply raise prices. They cite Danny Meyers and his Union Square Hospitality Group’s announcement that tipping will disappear in their restaurants to be replaced by higher prices. My friend and colleague Bruce McAdams @rovingprofessor) asserts that Danny is smarter than both of us (I retorted he was half right)and that he must be taking the right approach.

While I think price increases alone may (emphasis on may) be the right approach for Union Square, I am not convinced its right for everyone.   It may be a long term nightmare if everyone takes a different approach, but on an individual basis there may be an argument for a restaurant that wants to move away from tipping (see previous posts as to why) to go with a service charge or in fact, a combination of service charge and price increase.

There are several reasons:

Customers are used to tipping and a service charge lets them off the hook

It is a strong cultural norm to tip. We feel guilty if we don’t tip – even when service is bad. Even if a restaurant says the hospitality is included in the price, many diners may feel obliged to tip anyway. This has, in fact, been the case for some diners at the Union Square properties. Seeing a specific service charge may make it easier to let go of tipping. We also need to acknowledge that the size of the service charge may cause some issues with guests.

The impact on ordering patterns

An across the board price increase may induce sticker shock in diners. While a diner at the Modern is unlikely to be affected, there are definitely restaurants for which this will be an issue. A service charge, like a tip, comes after the meal and is likely have less impact on the specific ordering patterns of diners. An example may be a decline in appetizer or desert orders as entrée prices increase. Diners may also choose lower cost items which may generate less total margin. One of the objectives of the initiative is to raise funds to pay servers and kitchen staff. If diners buy less and average cheque does not increase as much as prices do then it becomes more difficult. The other objective, by the way, is to reduce some of the internal strife and challenges that arise from tipping (see previous posts).

I would highlight that a good revenue manager may be able to mitigate some of these impacts by varying the increase by menu item to try to reduce this phenomenon but that remains to be seen.

Fewer people entering the restaurant

This point is really a corollary to the one above. If people check a menu online or at the door and prices are higher than those of other restaurants in the choice set they may choose not to come in. This isn’t a problem if everyone is raising prices but as we transition it can be a source of lost business. The service charge is outside of the base price and much more intuitively linked to tipping.

Both approaches carry some risk and some benefits.   In some cases, generating enough revenue to achieve a restaurant’s goals may require both. A hybrid approach may provide additional revenue without requiring onerous price increases or a service charge well beyond the tip range customers are accustomed to.

We are seeing some momentum on ending tipping. It is by no means a sure thing that it will keep up. Individual restaurant owners will make individual choices that fit best for them. I don’t think that one size fits all. In some cases, in fact in my opinion more than half, a service charge will be the more effective way to make the transition.

One thought on “The Case for a Service Charge

  1. As one of the very few Ontario restaurants who pay a Living Wage and have abolished tipping, here are my experiences vis-a-vis your concerns:

    1) the guilt trip didn’t happen. We do accept tips, they go into a charity fund that is selected by the staff each month, and we find it isn’t that people feel they MUST tip, but that they want to show their appreciation for what we do by supporting the cause we have chosen. That said, we’ve seen these contributions slowly wane over the 6 months we’ve been in operation, not by much, but noticeably — it varies with the charity too, but even considering that, most people are comfortable with just paying a bill.

    2) people don’t shop restaurants by price, they shop by feel, by how much they like the place. I had a distinct advantage here because there was no place like the Avalon anywhere near Owen Sound, so there was no frame of reference on our prices. My bar prices were higher, but we’re not a “watering hole” so that’s not our business model, and even there, by focussing on local micro-craft vendors, there was no prior frame of reference — every shop in a downtown is somewhat ’boutique’ and so there was no qualms whatsoever about our prices being a tad higher than even the more traditional bars down the street.

    what’s more, certain of our items are intentionally under-priced. For example, I have an excellent coffee (Marley’s) being sold for nearly $0.50 less than anyone else in town sells the ordinary Mother Parkers, and yet I get very very few people who come in for a cup of coffee. Some of our other apps and late-night snacks are much lower than the competition offerings, and while there are those students who are regulars for my Cajun Poutine, such things were not the audience draw I had hoped!

    Even the 2-for-1 night or the half-price wings see no appreciable increase in traffic due to what amounts to a loss-leader.

    So I conclude that people do not shop based on price, they shop, I think, based first on habit, and second, on what they like, which is to say, they are reluctant to try anything new if what they’ve already got is already pleasing them.

    3) Fewer people entering the restaurant is, however, a problem. The other downtown business owners tell me it’s nothing peculiar to me, there just isn’t much spending going on downtown here this past year, several restaurants have packed it in — I own this one largely because the previous bar-owner couldn’t make a go of it and walked out on her lease, and in that respect there is a puzzle for revenue: we need to be more creative about what it is that we actually sell.

    And that may not be just food service. One of the cafes down the street does a lucrative trade catering office lunches, another has a knick-knack shop occupying half the floor, and another has home-decorating ideas, still another even has a barber shop! Diversification, I’m guessing that may be becoming a necessity in the modern age, at least for those of us who were aiming for the ordinary every-day out-for-a-pint kind of crowd.

    My own view on the ‘service charge’ is that it amounts to an increase in the price, because it is fixed, and so becomes as hated as the sales tax, yet another surprise tagged on to what you’d mentally computed from the menu. Service costs, that is just a simple fact and I think people are ready to accept that this isn’t 1954 anymore, a cup of coffee has real costs and those costs need to keep pace with society at large, and so that 10cent cup of coffee now costs $2 and wages need to do likewise. Adding a service tax just underlines that we’re only paying employees what they are worth because the consumer has been saddled with the cost all along and we’re now making what was voluntary goodness into, well, a tax. To my mind, it is more honest just to say “it costs me X to serve you Y, and I hope you trust me to be fair with my prices” because I do want to be fair with my prices, otherwise we’re back to problem #3!

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