And they were warned they had to "modernise" in order to meet existing and new demands.
ELWa, the post-16 funding body for Wales, published its corporate plan for 2004-07. Sheila Drury, chairman, said: "The learning and skills sector cannot expect to consume an infinitely increasing proportion of government spending.
"Second, the full benefits of new investments in learning cannot be realised without efforts to eliminate inefficiencies, releasing resources to reinvest in improving quality, creating innovative new learning experiences, and widening participation."
She told Fforwm, the Welsh association of colleges, that they had a challenging agenda which carried with it significant risk. "Change will not be easy, but the moral case is clear - current arrangements for funding post-16 learning are inequitable and unsustainable, and will prevent the realisation of the vision of Wales being recognised internationally as a 'learning country' with first-class education and training opportunities."
In the first year, existing mainstream provision would be protected but there would be no margin for growth or inflationary costs.
ELWa has concerns about leadership and management in the sector. About half of FE institutions are facing financial difficulties and there were "acute" issues of quality control in work-based learning.
Some of the problems are caused by different parts of the sector - school sixth forms, colleges, community learning - operating within different planning and funding mechanisms. This was inefficient and inequitable and meant that colleges and work-based providers received less funding than sixth forms.
ELWa's plan was to eliminate inefficiences and move the learning and skills sector towards a single, national funding model. Dr John Graystone, the association's chief executive, said much more had to be done to ensure colleges were treated equally. "It is simple, colleges must be funded adequately if they are going to deliver the Government's agenda."