In Drosophila, neural precursors are formed in a spaced pattern separated by intervening epidermal cells. Segregation of neural and epidermal lineages relies on cellular interactions. Failure of this cell communication, as in the mutants Notch (N), Delta, and shaggy, results in most or all of the cells becoming neural. Cells mutant for N and shaggy, but not Delta, autonomously adopt the neural fate when adjacent to wild-type cells in mosaics. Furthermore, wild-type cells adopt the epidermal fate if adjacent cells express a lower level of N activity than themselves, but produce neural precursors if adjacent cells express a higher level of N activity. This shows that there is competition between the cells and that the N protein is required for the mechanism whereby the cells choose between alternative fates. It also suggests that N acts as a receptor for an inhibitory signal emanating from the neural precursors.