Health Secretary Alan Johnson has axed a major contract with a private company to provide NHS diagnostic services.
Alan Johnson said targets were a blunt instrument
He also announced there will be no third wave of independent sector treatment centres (ISTCs) imposed by central government.
However, he has given the go-ahead for a new ISTC in Cumbria and Lancashire - and promised others in the future.
Mr Johnson also confirmed a two-thirds cut in NHS targets, but refused to move on nurses' pay.
The company which lost out - Atos Origin - was due to provide diagnostic services to the NHS in both the North West and South West.
Speaking to the health service select committee, Mr Johnson said: "They have failed to meet certain conditions within the contracts within an acceptable time frame."
However, the health secretary moved to defend government use of the private sector in the NHS.
He said ISTCs had been an "important part" of the government NHS reforms, and had "contributed to the spread of innovation and best practice".
The new service in the north of England will provide around 11,000 procedures a year for NHS patients, including general surgery and orthopaedics.
Mr Johnson said he expected to approve more similar schemes in the coming months.
"They would have to meet the local needs of patients, and offer value for money for the tax payer," he said.
"Where they meet the tests we will bring in ISTCs, where they are inefficient and not according to contract, we will end those contracts."
But Mr Johnson said instead of being imposed by central goverment, it would be down to local NHS bodies to decide if they wanted any more ISTCs in their area.
The centres have proved controversial amid accusations they "cream off" easy operations for maximum profit, leaving difficult cases to the NHS.
Last week, a report by the Healthcare Commission criticised the lack of quality data from ISTCs, which meant their work can not easily be compared with that in the NHS.
Shadow Health Secretary Andrew Lansley said: "This hails a clear break from Blair's public service reforms and adds to the confusion over the future direction of the NHS.
"Independent sector provision in the NHS is not the problem, rather it is Labour's inability to negotiate value for money contracts and create a level playing field for NHS providers."
Dr Jonathan Fielden, chairman of the BMA's consultants committee, said in many areas the need for an ISTC had been poorly assessed, and contracts under-utilised.
He said: "Local health trusts should think very carefully before signing deals with the private sector in the future.
"The independent sector should only be used when the NHS cannot provide the service locally and when it is truly value for money."
Confirming that centrally-imposed NHS targets would be slashed, Mr Johnson admitted they could distract health workers from important issues.
He said: "You don't need to have that kind of blunt instrument from the top.
"It's part of this looking up to Whitehall rather than looking out to their patients problem."
Mr Johnson also rejected calls to implement the full pay award for nurses in England.
Earlier this year, the government announced it would be staging a 2.5% pay rise for NHS workers, with a 1.5% pay rise in April followed by a further 1% in November, making an annual average of around 1.9%.
However, devolved administrations in Northern Ireland, Wales and Scotland have now agreed to pay the rise in full in one go.
Both the Royal College of Midwives and the Royal College of Nursing (RCN) are considering industrial action.
Dr Peter Carter, general secretary of the RCN, said: "Our campaign for pay justice for nurses is based on a very simple principle - one nursing family, one pay deal."