An early step in the development of vertebrae, ribs, muscle, and dermis is the differentiation of the somitic mesoderm into dermomyotome dorsally and sclerotome ventrally. To analyze this process, we have developed an in vitro assay for somitic mesoderm differentiation. We show that sclerotomal markers can be induced by a diffusible factor secreted by notochord and floor plate and that heterologous cells expressing Sonic hedgehog (shh/vhh-1) mimic this effect. In contrast, expression of dermomyotomal markers can be caused by a contact-dependent signal from surface ectoderm and a diffusible signal from dorsal neural tube. Our results extend previous studies by suggesting that dorsoventral patterning of somites involves the coordinate action of multiple dorsalizing and ventralizing signals and that a diffusible form of Shh/Vhh-1 mediates sclerotome induction.