Welsh universities and colleges will get no extra funding unless they have reorganised themselves into geographical and "functionally meaningful" collaborative clusters by the end of next year, the Welsh Assembly has said.
Reconfiguration of the sector tops a list of "something for something" funding conditions set out in an eight-year strategy by the assembly this week in response to the Welsh higher education review.
Legislation will be sought to give the Higher Education Funding Council for Wales strategic planning powers to guarantee that the changes are put in place.
But the assembly is also hoping that by dangling a funding carrot over its proposals there will be no need to use a stick.
The assembly's action plan, circulated yesterday, says that by 2010 higher education in Wales should be "defined less by institutions than by networks of excellence".
It wants to see institutions signing up to a variety of administrative, functional and subject-based collaborations, working through clusters that have a clearly identified mission.
Wales is set to follow England's lead in lifting the cap on student numbers. This will give the clusters more room for manoeuvre.
Restructuring will be supported with £3 million, and overall funding should rise to a level similar to Scotland in the long term. But the assembly said higher education grants would be increased above inflation unless its targets were achieved. "The outcomes we seek for higher education cannot be achieved without a radical drive towards collaboration and reshaping structures," it adds.
Grant conditions next year will be tied to "practical, costed and quantified results" from the sector over reconfiguration.
Subsequent increases in grant will be channelled through hypothecated funding streams tied to targets for access, third mission work, research, teaching, management and learner support.
In the longer term, these programmes will give way to block grants that will be subject to outcomes for the sector as a whole, the action plan paper says.
After reconfiguration, the next set of targets tied to funding will include increasing outside income, widening participation, improving research ratings by at least a third, improving institutions' financial status and increasing numbers of home and overseas students.