Although endochondral ossification of the limb and axial skeleton is relatively well-understood, the development of dermal (intramembranous) bone featured by many craniofacial skeletal elements is not nearly as well-characterized. We analyzed the expression domains of a number of markers that have previously been associated with endochondral skeleton development to define the cellular transitions involved in the dermal ossification process in both chick and mouse. This led to the recognition of a series of distinct steps in the dermal differentiation pathways, including a unique cell type characterized by the expression of both osteogenic and chondrogenic markers. Several signaling molecules previously implicated in endochondrial development were found to be expressed during specific stages of dermal bone formation. Three of these were studied functionally using retroviral misexpression. We found that activity of bone morphogenic proteins (BMPs) is required for neural crest-derived mesenchyme to commit to the osteogenic pathway and that both Indian hedgehog (IHH) and parathyroid hormone-related protein (PTHrP, PTHLH)negatively regulate the transition from preosteoblastic progenitors to osteoblasts. These results provide a framework for understanding dermal bone development with an aim of bringing it closer to the molecular and cellular resolution available for the endochondral bone development.