There is growing evidence to suggest that BMPs are among the signals necessary to create the embryonic skeleton, but how these regulatory molecules enter the pathways of embryonic bone formation remains to be defined. The earliest steps of endochondral bone formation, consisting of mesenchymal condensation and chondrogenesis, have been shown to result directly from BMP-2 action. To determine whether the transition from chondrogenesis to osteogenesis occurring later in endochondral bone formation is also the result of BMP activity, we tested the effects of BMP-2 on immortalized endochondral skeletal progenitor cells derived from mouse limb bud. The cell lines established by this process were found to fall into three general categories: undifferentiated skeletal progenitor cells, which in the presence of BMP-2 first express cartilage matrix proteins and then switch to production of bone matrix proteins; prechondroblast-like cells that constitutively express a subset of markers associated with chondrogenesis and, in the presence of BMP-2, shut off synthesis of these molecules and are induced to produce bone matrix molecules; and osteoblast-like cells that are not significantly affected by BMP-2 treatment. These data suggest that BMP-2 initiates the differentiation of limb bud cells into cells of both the cartilage and bone lineages in a sequential manner, making BMP-2 a potent regulator of skeletal cell differentiation.