Interaction between the epithelium and the mesenchyme is an essential feature of organogenesis, including hair follicle formation. The dermal papilla (DP), a dense aggregate of specialized dermis-derived stromal cells located at the bottom of the follicle, is a major component of hair that signals the follicular epithelial cells to prolong the hair growth process. However, little is known about DP-specific gene activation with regard to hair induction. In this study we demonstrate that a short fragment (839 bp) of the human versican (a core protein of one of the matrix chondroitin sulfate proteoglycans) promoter is sufficient to activate lacZ reporter gene expression in the DP of postnatal transgenic mice and also in the condensed mesenchyme (the origin of the DP) beneath the hair placode during hair follicle embryogenesis. Using the same versican promoter with green fluorescent protein (GFP), large numbers of fresh pelage DP cells were isolated from newborn transgenic skin by high-speed cell sorting. These GFP-positive DP cells showed abundant versican mRNA, confirming that the reporter molecules reflected endogenous versican gene expression. These sorted GFP-positive cells showed DP-like morphology in culture, but both GFP and versican expression was lost during primary culture. In vivo hair growth assays showed that GFP-positive cells could induce hair when grafted with epithelial cells, whereas GFP-negative cells grafted with epithelium or GFP-positive cells alone did not. These results suggest that versican may play an essential role both in mesenchymal condensation and in hair induction.