The formation of segmental grooves during mid embryogenesis in the Drosophila epidermis depends on the specification of a single row of groove cells posteriorly adjacent to cells that express the Hedgehog signal. However, the mechanism of groove formation and the role of the parasegmental organizer, which consists of adjacent rows of hedgehog- and wingless-expressing cells, are not well understood. We report that although groove cells originate from a population of Odd skipped-expressing cells, this pair-rule transcription factor is not required for their specification. We further find that Hedgehog is sufficient to specify groove fate in cells of different origin as late as stage 10, suggesting that Hedgehog induces groove cell fate rather than maintaining a pre-established state. Wingless activity is continuously required in the posterior part of parasegments to antagonize segmental groove formation. Our data support an instructive role for the Wingless/Hedgehog organizer in cellular patterning.