Economics of tipping

Tips are welcome in many occupations and are absolutely expected by restaurant servers who are paid well below the minimum wage.  Recently some restaurants have eliminated tipping, increased hourly wages and then hiked menu prices to compensate.

How do incentives change in a no-tip restaurant?  Under tipping the wait staff has two incentives: (1) provide good service because many customers have a "pay-for-performance" ethos and (2) upsell the customers because most base their tip on a percentage of the total tab.  In most cases tips are not shared with cooks and dishwashers, leading to less than optimal teamwork.  Finally tips are risky; restaurant traffic goes up and down with the weather and some customers are less than generous.  The result is partial alignment with the incentives of the restaurant owner.

Danny Meyer, CEO of Union Square Hospitality Group, has moved to the no-tip model.  The benefits, he argues in a recent WP op-ed, include more predictable income for wait staff and improved performance management (managers are in a better position to do this than customers).  But the implementation has been far from seamless.  With pay the same on every shift, servers who begged for weekend shifts (with their higher sales volume) now want to work the quieter weekdays.  Some customers balked at the higher menu prices, especially the ones that were less than generous tippers.

An incentive plan fiasco at Wells Fargo

NC State online MBA students have been studying incentive plans this semester.  The main motivation behind such plans is to change employee motivation to generate additional net income for the employer.

This week's revelations about Wells Fargo show how a poorly designed plan can backfire.  WF wanted its employees to cross-sell more accounts, e.g. get someone with a checking account to take out a mortgage.  Employees ended up with aggressive sales targets and thousands of them created new accounts without the customer's knowledge so that they could collect bonuses.

Maryland Smith Professor Clifford Rossi argues that none of the traditional lines of defense against such behavior held.  Line managers did not hold front line employees accountable until it was too late.  Corporate risk management missed all signals as well, ditto for internal audit.  According to WSJ, only 10% of the 5000+ employees who have been fired were at the branch manager level or higher.  No senior officers have departed yet.

While the plan was in effect the number of Wells Fargo products per household rose from 5.5 to 6.4 over a four year period.  And the four year period was 2009-2013, not exactly a time when people were taking out second mortgages to buy a new vacation home.

NYU finance prof Kermit Schoenholtz argues in the New Yorker that enforcement of financial regulations depends on bank self-monitoring.  Right now, that "mechanism isn't working."  Fines are supposedly designed to punish wrongdoing and send a message that banks will pay a stiff price if caught.

Wells has been fined $185m.  Net income in the 2nd quarter of 2016 was $5.6 billion.  The CEO John Stumpf still has his job.

NC legislature experiments with teacher incentives

Pay for public school teachers in North Carolina has been a big focus for the legislature over the last two years.  After no raises for many years, pay for starting teachers received a boost last year and pay for more experienced teachers is scheduled to increase this coming year.

This coming year's budget also includes two incentive plans that I would call unique.  One would allocate $10m to give a bonus to third grade teachers whose student growth scores place in the top 25%.  Bonus plans for individuals make sense when the employee has some control over the work environment and the metrics map reasonably well with employee effort and performance.  Although well-intentioned, I cannot help but wonder why the legislature did not consider two obvious problems with their scheme:
(1) Why put all the money on third grade teachers? Don't the other grades matter at least a little?
(2) Why didn't they select a more objective measure of actual learning?  The reward goes to the top 25%, regardless of how much or how little student growth took place.

The second plan pays a $50 bonus to Advanced Placement teachers for each student who passes the AP test.  So a student passes the AP Calculus test with flying colors, but is that because the AP teacher was so great or did it have something to do with the Algebra 1 and other teachers that they had before AP?  Also, what happens in parts of the state where school systems lack the budget to offer AP courses?  And should we be focusing incentive dollars on AP students or on those who are struggling to graduate?

The big mistake that legislators are making is the decision to use individual as opposed to group incentives.  Student achievement hinges on a collective effort of teachers from K to 12.  School-based plans are likely to be more effective than individual-based plans.

However, the third grade plan will solve one problem -- principals will not have any trouble filling open third grade positions!

Glaxo changes compensation plan for sales employees

Companies adopt compensation plans to better align the incentives of employees with those of the owners.  Commissions have traditionally been used in many sales jobs to encourage employees to sell as much as they can.  But that can lead the sales team to push product to every potential customer, regardless of whether the customer can use the product or not.

Bloomberg reports that GlaxoSmithKline is considering changes in its Patients First pay plan for sales employees.  The plan, launched in 2011, shifted the emphasis away from sales and toward "scientific knowledge, selling competency, customer evaluations, and overall performance of the representative's business unit."  The general idea is to reward the competencies that are believed to lead to strong customer relationships, as opposed to rewarding short-term, hardball sales tactics.  GSK is looking at making some adjustments to Patients First, including testing sales reps for product knowledge.  Looks like remembering those organic chemistry formulas has a payoff after all!