During Caenorhabditis elegans vulval induction the anchor cell of the gonad specifies a spatial pattern of three cell types among a set of six multipotent epidermal cells, the vulval precursor cells (VPCs). Previous studies suggested that the anchor cell produces a graded inductive signal which can directly stimulate VPCs away from a ground state (type 3) to become type 1 or type 2 depending on their distance from the anchor cell. Here, we investigate the interactions among VPCs in a mutant, lin-15, in which VPC fates are rendered partially independent of the inductive signal, and show that type 1 cells actively inhibit adjacent cells from also becoming type 1 cells. The fate of each VPC therefore depends on the combined action of two intercellular signals: a graded inductive signal from the anchor cell, and a lateral inhibitory signal from at least some of its neighbours. Pattern formation among the VPCs lin-15 mutant is analogous to the establishment of the pattern of neuroblasts and dermatoblasts during early insect neurogenesis, suggesting that the similarities in inferred molecular structure of the lin-12 and Notch gene products, which are involved in these two instances of pattern formation, might extend to similarities in function.