TSA Renegotiation
Pass-through with discipline is real pass-through.
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TSA pass-through pricing claims to flow third-party costs at cost. In practice, the line picks up margin in three or four ways that the buyer rarely sees on first read. This article maps where it hides, what the seller defends, and how to write pass-through language that holds as part of a complete TSA negotiation position.
Pass-through pricing is the contract mechanism for charging the buyer the seller's actual third-party cost. The seller pays a software license, a colocation invoice, a managed service fee, or a SaaS subscription. The seller then bills the buyer the same number with no mark-up. The line is supposed to be transparent. The invoice from the third party is the basis. The number on the buyer's invoice matches that basis.
In a clean carve-out, pass-through often covers the largest cost categories. Cloud spend across AWS, Azure, and GCP. Enterprise software where licenses are tied to the seller's master agreement. Network and circuit fees. Managed services delivered by third parties on behalf of the seller. Each category represents real money. A mid-sized TSA can run 40 to 60 percent of total value through pass-through lines, which is why the discipline on this section matters more than the discipline on cost-plus mark-up.
The seller's first draft typically defines pass-through in one or two sentences. The definition usually allows the seller to allocate costs based on its own internal methodology, to include reasonable administrative overhead, and to invoice without backup documentation. Each of those defaults moves margin from the buyer to the seller. None of them is necessary for the seller to operate the service.
The buyer's posture should be that pass-through means actual third-party cost, supported by invoice level documentation, with no allocation methodology, administrative fee, or volume discount retention. That posture is the baseline. The negotiation is then about what exceptions, if any, the seller earns. For more on the broader pricing context, see TSA pricing models explained.
The first hiding place is the volume discount. The seller buys cloud capacity, software licenses, or telecom at enterprise pricing that includes a volume discount. The pass-through line bills the buyer at list price, or at the seller's standard internal rate, or at the rate before discount. The discount stays with the seller. On large cloud bills, the differential can run 15 to 30 percent of total spend. The buyer pays the gross number while the seller keeps the discount.
The second hiding place is allocation methodology. The seller runs an enterprise agreement that covers many businesses, including Newco. The seller allocates a share to Newco using a formula that may overstate Newco's actual consumption. Allocation by revenue, by headcount, by historical usage, or by some weighted blend produces different numbers. The seller usually chooses the blend that maximizes Newco's share. Without contractual specificity, the buyer absorbs whatever the seller decides.
The third hiding place is the administrative fee. The seller adds a percentage on top of the third-party cost to cover the seller's procurement, finance, and vendor management activity. Two to five percent is common. The fee is framed as cost recovery, but it is mark-up by another name. A pass-through with an administrative fee is no longer pass-through. It is cost-plus on third-party spend.
The fourth hiding place is the credit and rebate. The seller earns credits from cloud providers for sustained consumption, software vendors for migration commitments, or telecom carriers for volume. The credits accrue to the seller's account. Without contract language requiring the seller to pass credits through, those credits remain with the seller while the buyer pays the gross invoice. Each of these patterns is documented in detail in TSA overcharge identification.
Pass-through language that holds has four characteristics. It defines actual cost using the invoice from the third party as the basis. It documents the allocation methodology in the contract rather than leaving it to the seller's discretion. It expressly excludes administrative fees, overhead allocations, and internal management charges. It requires the seller to pass through credits, rebates, and refunds when the seller receives them.
The actual cost definition should reference the third-party invoice net of any discount the seller actually receives. The seller's enterprise discount belongs to the buyer in proportion to the buyer's share of consumption. The contract should state this explicitly. Without that sentence, the seller has a defensible position that the discount is a feature of the seller's purchasing power and is not part of pass-through.
The allocation methodology section should specify the formula. If consumption is metered, the buyer pays for measured consumption. If consumption is not metered, the buyer pays a share based on a defined formula such as headcount, transaction volume, or storage usage. The formula should be auditable. The buyer should have the right to verify the underlying data each quarter. A formula stated in the contract is enforceable. A formula reserved to the seller's reasonable judgment is not.
The exclusion of administrative fees should be explicit. The contract should state that no overhead allocation, management fee, procurement charge, or other internal cost is included in the pass-through. If the seller wants compensation for its procurement activity, that compensation belongs in the cost-plus section as part of mark-up. Bundling it into pass-through produces a hidden fee that is invisible to monthly review.
Audit rights are the discipline that turns pass-through language into enforceable practice. The buyer should have the right to inspect the seller's records supporting pass-through charges. The right should cover invoices from third parties, allocation calculations, discount and rebate documentation, and consumption data. The right should be exercisable at the buyer's expense up to a defined threshold and at the seller's expense if the audit identifies material overcharge.
The quarterly review should include a sample audit. The buyer selects two or three pass-through lines each quarter and reviews the supporting documentation. The seller produces the third-party invoice, the allocation calculation, and any discount documentation. Discrepancies are reconciled through the standard governance process. The mechanism is light enough to operate continuously and serious enough to surface real issues. A complete view of the governance pattern is in TSA exit governance best practices.
The full audit right should be exercisable annually or on triggering events. A material change in pass-through cost. A dispute on a specific line. A change in the seller's procurement structure. The full audit covers all pass-through lines for a defined period and produces a written finding. Any overcharge identified is refunded to the buyer with interest. The structure produces real economic discipline, which is the only kind of discipline that holds over an 18 to 24 month TSA.
The buyer's posture on audit rights should be commercial, not defensive. The audit is part of the contract. Exercising it is the normal operation of a buyer who has paid for the service. The seller will sometimes characterize the audit as a sign of bad faith. The buyer should refuse that framing. The audit is part of the deal.
When the audit is run, the patterns surface quickly. Cloud spend is the most common location of overcharge. The seller bills at list price while paying at enterprise discount. The differential typically lands at 12 to 25 percent of cloud spend, which on a $4M annual cloud line is between $480K and $1M of recoverable value over the TSA period.
Software licenses produce the second pattern. The seller's enterprise agreement includes volume tiers. The pass-through bills Newco at the seller's blended internal cost, which exceeds the marginal cost of adding Newco users. The differential is smaller in percentage terms but still meaningful. A clean reading of the enterprise license agreement usually shows the structure.
Managed services and third-party labor are the third pattern. The seller subcontracts work to a third party at a negotiated rate. The pass-through bills the buyer at the seller's posted internal rate, which carries mark-up. The contract sometimes allows this. Sometimes it does not. A close reading is required. When the contract requires actual cost, the differential is recoverable.
Telecom and network charges are the fourth pattern. Volume rebates accrue to the seller. Negotiated rates apply to the seller's master agreement. The pass-through invoice rarely shows either. The audit identifies the gap. The recovery is meaningful on multi site portfolios where telecom spend is concentrated. The complete tactical playbook for reducing pass-through cost is in TSA cost reduction tactics.
The two main pricing models in a TSA, what each implies for buyer risk, and when each one is the right answer.
Read the article →What seller mark-ups actually look like across industries and what the defensible buyer position is.
Read the article →The audit rights that turn pass-through language into enforceable practice through the TSA period.
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