The Performance Funding Project of the Tennessee Higher Education Commission to improve the current appropriations formula in Tennessee is discussed. The major project objective is to explore the feasibility of allocating some portion of state funds on a performance criterion, as compared to allocating funds solely on an enrollment criterion. It is assumed that funding will continue to be primarily based on enrollment, but that a complementary feature might be built into the formula to promote institutional diversity and improved instructional performance. Pilot projects were undertaken at 11 public colleges and universities. The first project year called for the development of institutional-wide instructional goals and associated indicators of performance and the second year for the acquisition of data on these performance indicators and the exploration of funding policies that might promote and reward effective performance. Some observations based on the first project year include: performance funding is a difficult concept to communicate; the possibility of statewide indicators of institutional performance was opposed by campus personnel, who also dislike campus-based indicators; faculty and administrators are concerned about the unintended outcomes of performance criteria funding like the possibility of punitive funding; arriving at goals and indicators that cut across departmental lines is difficult; faculties across Tennessee are very concerned about instructional performance; attention is being directed to what constitutes minimum competence for a college degree; and sets of goals and indicators seem to be taking on a unique character at each institution. An overview on formula funding is also included. (SW)