Why do we leave tips for some service but not for others?


It has become customary at most places to leave 15-20% of the total bill as a tip for good service at restaurants. But it is illegal to tip some service providers. For instance, the clerk at your immigration office.
Why this distinction?

If we go back, tipping in restaurants originated to induce better service. Restaurant owners are willing to reward attentive and courteous servers, since better service leads to repeat customers. And the reward incentivizes waiters to put in extra effort to improve the dining experience.

One way to achieve this is that owners monitor their staff and reward them accordingly. However, this is painstakingly difficult. An elegant solution devised by restaurant owners was to reduce the price of food slightly and leave the onus to the diners by announcing that they leave a bit extra if they are pleased with the service. Diners are perfectly positioned to monitor service quality.

From a diners perspective his willingness to pay remains the same as earlier as the reduction of list price of the meal compensates for the tip.
They are at an advantage since competition in restaurant industry makes it difficult for servers to exploit less generous customers by withholding quality service. Customers can always choose a different place to dine, the next time.

Now imagine you go to your Immigration and Checkpoint Office (ICA) to renew your residency permit. ICA is what you would call a monopoly. If tipping was made customary, due to lack of competition, clerks would refuse to serve you without a generous tip. Thus tipping is illegal in services without market competition.



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Why are hotel minibar prices so Exorbitant?




You must have often wondered why the can of coke, stacked in your Hotel room's minibar is priced as high as $4 when you can get one from a vending machine or the mart, right across the road for a buck. What justifies this high markup on the hotel minibar items?

If you guessed the hotel is exploiting the price you are willing to pay for the convenience, you are not entirely wrong.

This is what I think.
The vending machine or the mart sell in high volumes and can take advantage of the efficiencies of scale and specialization, enabling them to price the can a lot lower. This could justify, say an additional dollar for the Hotel to cover the cost of selling the can, in order to recover it's fixed and variable costs. But why $4 and not $2?

Hoteling is an expensive Business to run. It has a high fixed cost which has to be incurred irrespective of the number of occupants. Land, Building Cleanliness, maintenance, utilities, floor staff etc. Marginal cost for each new guest is relatively low. Thus ideally they need high occupancy rates to recover their sunk costs.

Hoteling Business is quite competitive (in most places) and to achieve higher occupancy rates, hotels are under pressure to offer competitive prices. The additional markup is a neat mechanism for the hotel to target discounts to price sensitive customers.

Many hotels provide discounted rates to Internet bookings, which is consistent with evidence that Internet users are more price sensitive and have lower search cost due to readily available information to compare and contrast.

Due to this competition, hotels do not enjoy high profit margins by renting out rooms. Since they have to charge uniform prices, and in order to offer higher discounts (and stay competitive) , they must find a way to collect additional revenue from the less price sensitive guests.

Hotels perfectly know that offering minibar items at inflated price results in lesser takers. But they also know that guests who are less price sensitive are willing to forego the high prices for the added convenience. Hotels can use this surplus (in form of additional revenue) to offer deeper discounts to an average guest.

Now imagine a hypothetical case where Hotels can perfectly discriminate room prices based on your willingness to pay. That is, if each guest pays a different price for the same room, you wouldn't see an inflated minibar since the Hotel has already extracted all the Consumer surplus.

Since the above is really hard to implement, a common price discrimination tool is to offer tiers of hotel rooms- Standard, Deluxe, Royal Suite etc, each clearly differentiated and targeted. Surplus from the more expensive suits can be used to subsidize the lower tiers, ensuring higher occupancy rates.

This is similar to airlines pricing economy and Business class seats.

The hotel minibar problem is yet another really interesting problem where the Consumer behavior affects the way the Supplier prices his goods, with an intention of at least breaking even amidst intense market competition.

So, what do you think about the Hotel Minibars. Please leave your comments.
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