Inspectors have been told to pay special attention to any colleges which fail to meet targets on retention and achievement. All colleges will need to account publicly for their performance.
The Further Education Funding Council said this week that too many students withdrew from their courses or failed to complete their final assessment satisfactorily. Significant improvements were vital and "improved levels of retention and achievement must become a priority throughout the sector if it is to demonstrate convincingly that it provides the best service for students and value for the public purse.
"The council will not hesitate to take action if those colleges exhibiting consistently poor performance do not improve the quality of their work and the attainments of their students."
The council's draft guidance - the second stage of its drive to improve standards - asks for college's responses to the principles, format and timetable for target setting.
It follows the publication last month of benchmarking data (tables of statistical standards across different types of college and course) which will enable institutions to measure their progress.
Both papers form part of the FEFC's Quality Improvement Strategy, the council's response to growing concern in the sector and in Parliament at worrying levels of students' failure and drop out.
Earlier this year the House of Commons Public Accounts Committee described as "a matter of serious concern" the fact that in around 10 per cent of colleges in England less than half the students achieve the qualification they enrolled for.
However, the draft guidance stresses that colleges should not seek improvements at the expense of involvement. "In taking action to raise levels of retention and achievement, colleges should not neglect the many important and creative initiatives which have brought further education into the lives of an increasingly diverse community of students."
Colleges should establish "a regular regime of target-setting, monitoring and reporting on performance, leading to actions which remedy weakness in provision and consistently raise levels of student achievement," the circular advises.
Jim Donaldson, the FEFC's chief inspector, said that the introduction of target setting represented one of the most important developments in FE for years. "More than 90 per cent of colleges agreed that we should produce guidance on target setting when we consulted on the quality improvement strategy. We do not propose to set targets for individual colleges. Instead, we expect to see colleges setting their own challenging targets and to see year-on-year improvements.
"We intend to continually support the sector in aiming to improve quality, and we will publish the annual reports of the target setting process," he added.
The next important date in the quality improvement strategy comes next March when colleges will be required to provide data on their achievements for 199798 and agreed targets for 199899.