Unveiling The Mystery: How Asymmetric Information Shapes Our Service Charge?

 

(Copyright: CFI Team) Available at:https://corporatefinanceinstitute.com/resources/wealthmanagement/service-charge/

Have you ever found yourself dining at a restaurant, only to be left wondering about the mysterious journey of the service charge on your bill? It’s a familiar tale–we enjoy our meal, pay the bill, yet remain in the dark about the intricate workings behind the scenes. In economics theory, this phenomenon is known as asymmetric information–a situation where one party involved in a transaction possesses more or superior information compared to the other party. (Bloomenthal, 2021).

Here’s where it gets intriguing: as you enjoy your meal, the inner workings of the restaurant’s payment system remain a mystery to you. Take, for instance, the most popular brunch place known as Federal in Manchester. As you sip your freshly brewed coffee and indulge in their famous French toast, you’re unknowingly participating in this intricate dance of service charge distribution. While you’re enjoying in the ambiance and flavours, the staff at Federal are working tirelessly to ensure your visit is nothing short of delightful.

You might assume that the service charge is going straight to your server, but in reality, it could be divided up among various staff members, including cooks, cleaners and managers.

Why it matters to you? This lack of clarity can affect your perception of the service charge. You might wonder if you’re being charged extra for something without knowing exactly where your money is going. It’s like paying for a mystery box-You are not sure what’s inside.

In fact, it's not just customers like you who are facing the mystery box. There is an invisible economic drama unfolding, in which the principal-agent problem plays the leading role. Let's break it down: The folks running the show in Federal (the principals) have all the power to decide where bit of that service charge you pay ends up. Meanwhile, the staff (the agents), not only the waiters, will not know exactly how much of their excellent service can be translated into a bigger slice of the pie.

Why? Because the principal-agent problem is all about mismatched goals. Rational owners’ goal will always be generating more profits, it is reasonable for them to utilise the information asymmetry with the staff by injecting service charges into the profit pool. In contrast, the staff just want to be fairly paid for their hard work, but all they can do is speculate on how much they will get out of that mystery box for their efforts. It's like attending a race without knowing if there will be a trophy at the finish line. What's more, if they end up with less than what they expect, it can really take the wind out of their sails when it comes to giving great service.

In essence, it all comes down to the transparency of that mystery box. If the owners clarified how the service charge benefits the service stars, we could all enjoy a better experience - who doesn't like to know what they're really getting, or paying for, especially when it's as good as the French toast at Federal?

Shall we gamble on what’s in the mystery box? With transparency, customers can skip the uncertainty and pay for what exactly they value. Cartwright (2018) states that it provides a solution for the concept of bounded rationality, where individuals make decisions based on limited information. Transparency acts as a beacon to reduce uncertainty, guiding customers to make smart choices.

In economics, transparency is vital for a fair and efficient market. When customers, employees, and owners all have the same information about the service charges, they can better figure out what to expect and decide whether it aligns with their idea of fairness. It's a win-win for everyone.

Transparency not only draws in talented workers but also helps retain them. Competitive wages and a transparent payment system make employees feel valued and satisfied, which in turn enhances the quality of services. Also for staff, fair compensation ensures that they enjoy a consistent income and acknowledgement for their hard work. Imagine the satisfaction knowing your dedication is recognised and appreciated not only by your customers you serve but also by your employer. This recognition fosters your sense of job loyalty. Furthermore, transparency cultivates trust and loyalty among customers to this restaurant. When customers understand how their money is being utilised, it reaffirms their confidence in the restaurant’s ethical standards.

So, next time you encounter the mystery box, keep this in mind: transparency isn't just a buzzword—it's your ticket to a fairer, more trustworthy and equitable dining experience. As we move towards a cashless society, the way service charges are allocated has become less transparent. More and more people are questioning whether these fees are really going to those who serve us.

To address this concern, government intervention might be the answer. Take the UK as an example, in January 2024 the UK government passed a law to ensure that 100 % of the service charges go directly to the waiters (Department for Business & Trade, 2023). This is the government’s response to the incident of Pizza Express was accused of deducting fees from “tronc” (the communal tip pot) in 2015 (BBC news, 2015). This new law aims to clear up any confusion and ensure fairness in the service industry.

But the UK government isn’t stopping there, the Department for Business & Trade in the UK has been also drafting a code of practice aiming to set clear and fair standards for distributing tips. This is all about fostering a transparent and fair environment in the service industry.

With these regulations, the UK government is tackling the public’s concerns of service fees, clarifying and standardising how service charges should benefit both employees and employers. Ultimately, the legislation helps to maintain fairness and integrity in the service industry plagued by information asymmetry, proving that when transparency is prioritised, everyone gains.

Reference List:

BBC news. (2015). Pizza Express: The war over tipping. [online]. Available at: https://www.bbc.co.uk/news/magazine-34146032. (Accessed: April 10, 2024)

Bloomenthal, A. (2021) Asymmetric Information in Economics Explained. Available at: https://www.investopedia.com/terms/a/asymmetricinformation.asp. (Accessed: April 1,2024)

Cartwright, E. (2018). Behavioral economics. Third edition. London: Routledge, pp.11.

Department for Business & Trade. (2023). Draft code of practice on fair and transparent

distribution of tips. [online] Available at: https://www.gov.uk/government/consultations/distributing-tips-fairly-draft-statutory-code-ofpractice/draft-code-of-practice-on-fair-and-transparent-distribution-of-tips-html-version. (Accessed: April 2, 2024)

Department for Business & Trade . (2023). Employment (Allocation of Tips) Act 2023. [online] Available at: https://www.legislation.gov.uk/ukpga/2023/13/enacted. (Accessed: April

2, 2024)