The cellular events underlying skeletal morphogenesis and the formation of cartilage templates are largely unknown. We generated an imaging system to dynamically visualize limb mesenchymal cells undergoing successive phases in cartilage formation and to delineate the cellular function of key regulators of chondrogenesis found mutated in chondrodysplasia syndromes. We uncovered an unsuspected role for Sox9 in control of cell morphology, independent from its major downstream target ColIIa, critically required for the mesenchyme-to-chondrocyte transition. In contrast, Bmp signaling regulates a cellular program we term "compaction" in which mesenchymal cells acquire a cohesive cell behavior required to delineate the boundaries and size of cartilage elements. Moreover, we visualized labeled progenitor cells from different regions of the limb bud and identified unique cellular properties that may direct their contribution toward specific skeletal elements such as the humerus or digits. These findings shed light on the cellular basis for chondrodysplasia syndromes and formation of the vertebrate skeleton.