Given the inadequacies of existing repair strategies for cartilage injuries, tissue engineering approach using biomaterials and stem cells offers new hope for better treatments. Recently, we have fabricated injectable collagen-human mesenchymal stem cell (hMSC) microspheres using microencapsulation. Apart from providing a protective matrix for cell delivery, the collagen microspheres may also act as a bio-mimetic matrix facilitating the functional remodeling of hMSCs. In this study, whether the encapsulated hMSCs can be pre-differentiated into chondrogenic phenotype prior to implantation has been investigated. The effects of cell seeding density and collagen concentration on the chondrogenic differentiation potential of hMSCs have been studied. An in vivo implantation study has also been conducted. Fabrication of cartilage-like tissue micro-masses was demonstrated by positive immunohistochemical staining for cartilage-specific extracellular matrix components including type II collagen and aggrecan. The meshwork of collagen fibers was remodeled into a highly ordered microstructure, characterized by thick and parallel bundles, upon differentiation. Higher cell seeding density and higher collagen concentration favored the chondrogenic differentiation of hMSCs, yielding increased matrix production and mechanical strength of the micro-masses. These micro-masses were also demonstrated to integrate well with the host tissue in NOD/SCID mice.