We investigated the mechanism of tissue induction and specification using the lacrimal gland as a model system. This structure begins its morphogenesis as a bud-like outgrowth of the conjunctival epithelium and ultimately forms a branched structure with secretory function. Using a reporter transgene as a specific marker for gland epithelium, we show that the transcription factor Pax6 is required for normal development of the gland and is probably an important competence factor. In investigating the cell-cell signaling required, we show that fibroblast growth factor (FGF) 10 is sufficient to stimulate ectopic lacrimal bud formation in ocular explants. Expression of FGF10 in the mesenchyme adjacent to the presumptive lacrimal bud and absence of lacrimal gland development in FGF10-null mice strongly suggest that it is an endogenous inducer. This was supported by the observation that inhibition of signaling by a receptor for FGF10 (receptor 2 IIIb) suppressed development of the endogenous lacrimal bud. In explants of mesenchyme-free gland epithelium, FGF10 stimulated growth but not branching morphogenesis. This suggested that its role in induction is to stimulate proliferation and, in turn, that FGF10 combines with other factors to provide the instructive signals required for lacrimal gland development.