Bone augmentation via tissue engineering has generated significant interest. We hypothesized that periosteum-derived cells could be used in place of bone marrow stromal cells (which are widely used) in bone engineering, but the differences in osteogenic potential between these 2 cell types are unclear. Here, we compared the osteogenic potential of these cells, and investigated the optimal osteoinductive conditions for periosteum-derived cells. Both cell types were induced, via bFGF and BMP-2, to differentiate into osteoblasts. Periosteal cells proliferated faster than marrow stromal cells, and osteogenic markers indicated that bone marrow stromal cells were more osteogenic than periosteal cells. However, pre-treatment with bFGF made periosteal cells more sensitive to BMP-2 and more osteogenic. Transplants of periosteal cells treated with BMP-2 after pre-treatment with bFGF formed more new bone than did marrow stromal cells. Analysis of these data suggests that combined treatment with bFGF and BMP-2 can make periosteum a highly useful source of bone regeneration.