Effective long-term treatment of Type 2 Diabetes Mellitus (T2DM) implies modification of the disease processes that cause this progressive disorder. This paper proposes a mechanism-based approach to disease progression modeling of T2DM that aims to provide the ability to describe and quantify the effects of treatment on the time-course of the progressive loss of beta-cell function and insulin-sensitivity underlying T2DM. It develops a population pharmacodynamic model that incorporates mechanism-based representations of the homeostatic feedback relationships between fasting levels of plasma glucose (FPG) and fasting serum insulin (FSI), and the physiological feed-forward relationship between FPG and glycosylated hemoglobin A1c (HbA1c). This model was developed on data from two parallel one-year studies comparing the effects of pioglitazone relative to metformin or sulfonylurea treatment in 2,408 treatment-naïve T2DM patients. It was found that the model provided accurate descriptions of the time-courses of FPG and HbA1c for different treatment arms. It allowed the identification of the long-term effects of different treatments on loss of beta-cell function and insulin-sensitivity, independently from their immediate anti-hyperglycemic effects modeled at their specific sites of action. Hence it avoided the confounding of these effects that is inherent in point estimates of beta-cell function and insulin-sensitivity such as the widely used HOMA-%B and HOMA-%S. It was also found that metformin therapy did not result in a reduction in FSI levels in conjunction with reduced FPG levels, as expected for an insulin-sensitizer, whereas pioglitazone therapy did. It is concluded that, although its current implementation leaves room for further improvement, the mechanism-based approach presented here constitutes a promising conceptual advance in the study of T2DM disease progression and disease modification.