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Danny Meyer's Economically Nonsensical Solution to the Tipping 'Problem' In eliminating tipping at his restaurants, Danny Meyer just may have proven how necessary gratuities are.

By Ray Hennessey Edited by Dan Bova

Opinions expressed by Entrepreneur contributors are their own.

TEDx | Livestream
Shake Shack Founder Danny Meyer speaking at TEDx

In eliminating tipping, Danny Meyer just might have saved tipping.

Meyer, the restaurateur and entrepreneur, is once again making a splash, saying he will eliminate tipping at his restaurants. It's a characteristically bold move, though Meyer isn't the first. Several restaurants in New York and around the country have done away with tipping, saying it is an archaic practice that creates unfair work environments for restaurant workers. Tipping is often cited as a hindrance to raising minimum-wage laws across the country because those who work for tips generally make more than those who don't, so much so that tipped minimum wage is always significantly lower than the minimum wage for the rest of the workforce.

In New York City, home of Meyer's empire, there's an added wrinkle. If you make tips, the minimum wage is $5. The rest of the workforce is $8.75. But, if you flip burgers at McDonald's, there's a separate fast-food minimum wage of $10.50.

Clearly, that doesn't make sense. A waiter at, say, Gramercy Tavern, should not be making less than half the wage of a person whose job it is to place three pickles quickly on a nearly tasteless cheeseburger. The skills are different. The customer interaction is different. The level of education needed is different.

That wage scheme doesn't work at all -- unless you add in tipping. A waitress at Gramercy Tavern doesn't make $5 an hour. Nor does she make $10 an hour. Likely, she makes the equivalent of $20 or $30 or more an hour, provided she's very good at her job. But the back end of the restaurant -- the workers who scrape and clean the dishes, etc. -- are more affected by low wages, and rely on the largesse of the front end of the staff to share in the tips they've earned.

Eliminating tipping -- and tipping wages -- fixes that by becoming a great equalizer. You can pay people a flat, predictable rate, raising the pay of everyone at the restaurant. Suddenly, everyone gets a fair wage, free from the tyranny of having the patrons assess your performance by how much (or, more to the point, how little) they add extra to the bill.

Like every government program ever proposed, Meyer's plan sounds great on principle but makes no sense economically when one ponders how one pays for this. Meyer knows that, to bring pay up for some staff and ensure he can retain the best, he has to risk lowering the pay for the servers themselves. After all, they are the gateway for tips, and they have relied on their skills to generate their income. So, in truth, servers will make less on paper, while cooks, bottlewashers and hostesses presumably will make more.

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Why won't the serveurs leave en masse? Well, Meyer plans to supplement everyone's income through a revenue-share program. It's like profit-sharing. The more volume a restaurant gets, the more money can be shared with the staff, and, presumably, the servers will get more of that. It's the culinary version of "from each according to his ability, to each according to his need."

Now, those of you who learned math in the era before Common Core realize that, in order to make this work financially, you need to bring in more money to the restaurant itself. Higher costs need higher revenue. Meyer has solved this problem by -- you guessed it! -- raising prices for consumers. How much? That's yet to be determined, but one has to assume a minimum of 20 percent, just to keep up with lost tips. But that won't be sufficient, since lost tips themselves wouldn't pay for the increases you're offering to the entire staff. (Remember, this is about paying everyone more.) So, it is safe to say that the minimum increase needs to be at least in the 25 percent to 30 percent range.

At the aforementioned Gramercy Tavern, that means your appetizer of fish croquette, with carrots, grilled cilantro and yogurt goes from $16 to $20, while the main dish of grilled pork shoulder, served with peppers and dirty rice goes from $24 to at least $30. A fast-food worker would have to spend an hour and half's worth of his pay just to afford the $16 blackberry caramel flan, covered with candied walnuts, thyme and maple syrup. Don't even get me started on the wine. (No, really. Don't let me get started. I'd go broke.)

Now, you might say raising prices isn't a big deal. Meyer, after all, caters to the wealthy at restaurants like The Modern, and the 1 percent can afford the added 30 percent. True, but that isn't the point. A patron who would gladly tip $6 on a $24 bill doesn't see that as a transaction for the total experience. He sees it as worth the $24 for the meal and ambience, and $6 for the professionalism of the service provided. Taking away the opportunity to honor that service, saying it is just part of the package, makes the dining experience an entirely different transaction, and some might not want to take part.

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Also, tipping is not a right, despite what some of the rhetoric says nowadays. It is the ultimate meritocracy, whether you're a caddy, a stripper or waiter at a steakhouse. You earn tips, based on service. For all the Facebook pictures of checks where some idiot stiffed a server, those occurrences are rare. Many people tip regularly, based on what they get in return. A tip is a free-market Like button on the bill of fare, a way to express satisfaction or concern with the experience provided. You have no right to tips, but there is upside available in seeking them. You risk getting the shaft from one or two bills with the opportunity to get the reward from a handful that are in excess of what you would otherwise deserve. That's what waiting tables is all about. If you take away a patron's ability to express their opinion, the only recourse the patron has is to simply never go back and eat a meal there again.

That's a problem, because, even with the price hikes, Meyer's numbers still don't work unless you also add even more volume. Economically speaking, it is very difficult to raise prices and increase volume, particularly in a city like New York, where you have a ton of fine-dining choices.

Oh, and as Eater pointed out, costs in general are going up. Meyer will "end up paying higher credit card processing fees because of the higher prices. He'll have to renegotiate with landlords who calculate his restaurants' rent based on a percentage of topline revenue. (This kind of arrangement is standard practice, and it means that the real estate suits could reap a windfall simply as a result of higher prices — without greater sales.) And he'll say goodbye to the FICA credit, part of a law that gives restaurants huge breaks for 'paying' waiters in tips, which for a group of USHG's size translates to $1 million to $1.5 million in annual tax credits."

So, to recap, his costs will rise, his wages will rise, and his prices will rise, and he needs to create higher volume to even come close to making it work. From a marketing, messaging and political standpoint, it is a bold move. Economically, it's folly.

To his credit, Meyer isn't saying he has figured this out yet. It will be rolled out over the next year, and he doesn't yet have the revenue-sharing formula in place, nor does he know what the actual pay rates will be for the front or the back of the houses.

"I don't have a crystal ball," Meyer told Eater. "We could be dead wrong on this thing."

So that means there will be experimentation -- ironically on the backs of the livelihoods of the very employees he is trying to help. It will be trial and error, and the results will be seen in the paychecks themselves. If it doesn't work, the risk is that the restaurants will shutter. Anyone laid off will tell you a moderate wage is better than no wage at all.

There is, humbly submitted, a model that might work. Keeping dinner prices under control (whatever that means by Manhattan standards) can attract customers and increase volume. You can manage costs by putting more incentive on the staff that has the most interactive with the customers, and even place the burden of those incentives on the patrons themselves, to maintain your own profits and give you the flexibility to hire even more staff and maybe even make modest pay increases across the board.

That model makes a lot of sense. It's called gratuities. Danny Meyer has finally given the industry its best economic defense of the good ol' tip in a while.

Related: A Failed CEO Is Better Than a Successful Politician

Ray Hennessey

Former Editorial Director at Entrepreneur Media

Ray Hennessey is the former editorial director of Entrepreneur.

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