Poorly performing colleges will have their funding cut and given to those that meet or exceed their educational targets under plans to make further education more efficient and responsive to learner needs.
The move would reconfigure FE funding as a needs-based rather than a demand-led system, said Geoff Russell, chief executive of the Learning and Skills Council.
"The people that have a low record of achievement for the students they put through can expect that we will allocate more money away from them," he said. "This means the money is going to providers that can do the best job."
Mr Russell said that judgments on quality might rest upon the numbers of people at each college who successfully complete the courses they started on.
"It means we assess the performance of our providers," he said.
Mr Russell said care would have to be taken to ensure that colleges were not penalised unfairly if, for example, they happen to educate lots of students from areas of high deprivation, who are statistically more likely to fail to complete their courses because of personal, financial and educational circumstances.
"We will take into account the student mix so there is some value added measure, plus we will be doing some kind of mystery shopping to assess how learners feel. The trick is applying that carefully," Mr Russell said.
The LSC transfers its funding duties to the Skills Funding Agency and local authorities from next April, and Mr Russell said he hopes to lay the ground work on funding for the council's successor bodies.
John Denham, the Skills Secretary, backed a harder line on funding in a letter to the LSC last week. He said the projected slower rate of growth in public spending meant FE had to take a longer-term view of how to deliver provision efficiently.
"I want to see more incentives for the development of courses and qualifications that meet strategic skills needs," Mr Denham said.
"In particular, I would like the council to take a robust approach to withdrawing funding from poorly performing providers and colleges."
He asked colleges to find pound;240m of efficiency savings in 2010-11. A further pound;100m is expected to come from the budgets of intermediary bodies and administration.
Asha Khemka, principal of West Nottinghamshire College, welcomed Mr Russell's proposals.
"There will be winners and losers," she said, "but as long as colleges have flexibility over provision and the system takes into account modular curricula and valued added measures, then I do not see why we should not have performance-based recognition.
"We have to drive standards up and if this challenges weaker providers to improve their performance, then it is a good thing."