During embryogenesis, body pattern is established in a stepwise process. After specification of the body axis, the embryo is subdivided into smaller units. Within these units, a diverse array of cell types is then generated. The subdivisions of the Drosophila embryo, called parasegments, are defined by the interface between cells expressing the homeoprotein Engrailed and cells expressing the secreted protein Wingless. We have examined the generation of cell-type diversity within parasegments by focusing on the choice of cell fate made by the engrailed (en)-expressing cells. These cells differentiate as one of two alternative cell types. We report here that this choice is mediated by wingless (wg), in a function distinct from its early role maintaining en expression. Thus, en cells exhibit different responses to the wg signal at different developmental stages. Early wg input stabilizes the subdivision of the body axis by maintaining en expression, whereas later input generates cell-type diversity.