Dermal papillae (DP) play a pivotal role in hair formation, growth and cycling. However, the number of DP is limited. In this study, we report the production of "reconstructed DP" by enclosing DP cells within an alginate-polylysine-alginate (APA) semipermeable membrane. MTT assay and electron microscopy showed that the microencapsulated dermal papilla cells retained normal activity. The microcapsules were implanted into rat footpads, which lack follicles and sebaceous glands, to assess their inductive properties. Histologic examination showed that numbers of follicle and sebaceous gland structures formed in the footpads within 6-10-week period. At the 10 weeks following transplantation, hair fibers were visible in the footpad. These findings indicate that the DP cell microcapsules retain the capacity to initiate follicle regeneration and could be considered a substitute for fresh isolated DPs.