Vertebrate craniofacial sensory organs derive from ectodermal placodes early in development. It has been suggested that all craniofacial placodes arise from a common ectodermal domain adjacent to the anterior neural plate, and a number of genes have been recently identified that mark such a 'pre-placodal' domain. However, the functional significance of this pre-placodal domain is still unclear. In the present study, we show that Fgf signaling is necessary and sufficient to directly induce some, but not all, markers of the otic placode in ectoderm taken from the pre-placodal domain. By contrast, ectoderm from outside this domain is not competent to express otic markers in response to Fgfs. Grafting naïve ectoderm into the pre-placodal domain causes upregulation of pre-placodal markers within 8 hours, together with the acquisition of competence to respond to Fgf signaling. This suggests a two-step model of craniofacial placode induction in which ectoderm first acquires pre-placodal region identity, and subsequently differentiates into particular craniofacial placodes under the influence of local inducing signals.