Tipping, firm strategy, and industrial organization

Tipping is a phenomenon that has been studied for many years, but is receiving increased attention in recent years. The magnitude of tips is very large – in the US, for example, tips in the food industry alone amount to about $42 billion each year, and tips are given in many other establishments and countries, so annual worldwide tips are much higher than that. Millions of workers in the US alone derive most of their income from tips and tipping is prevalent in numerous countries and occupations. These are all good reasons to study tipping, but it is clear that tipping has created much interest also because it is puzzling from a theoretical perspective. The common assumption in economics that people maximize utility (which is derived by consuming various goods) subject to a budget constraint implies that people should give up money only when they receive something in return. This is not the case, however, when people tip: service has already been provided by the time the tip is given, so the tip is a voluntary payment that does not buy something real (such as improved service) in return. The literature on tipping can be divided to two main areas. The first area can be termed "understanding tipping behavior." This includes studies that try to understand why people tip, what affects their tipping behavior, why tipping is different across countries, etc. The second research area, which started to receive attention more recently, can be defined as "tipping, firm strategy, and industrial organization." This part of the literature deals with the effect of tipping on firms and markets. For example, firms can sometimes choose between voluntary tipping and compulsory service charges – which one is better for the firm? How should the existence of tips affect optimal pricing by the firm? How should firms monitor workers and provide incentives to them when tipping exists? Why does tipping exist in some industries but not in others? Does tipping increase social welfare in industries in which it is the norm? All these questions belong to this second research area and demonstrate the close relationship of tipping to industrial organization and firm strategy. Several review articles made an attempt to summarize and synthesize the extensive literature in the area of understanding tipping behavior, but no article has offered an extensive literature review that focuses on the area of "tipping, firm strategy, and industrial organization." The purpose of this paper, therefore, is to review and summarize the literature in this area of research.