As mesenchymal stem cells (MSCs) are capable of self-renewal and multilineage differentiation, the feasibility and efficacy of co-culturing human MSCs (hMSCs) with rabbit articular chondrocytes (rACs) to promote chondrogenic and osteogenic differentiation of hMSCs for clinical osteoarthritic therapy were investigated in the present study. The two distinct cell types were encapsulated in alginate hydrogels singly or in one of three ratios (2:1, 1:1, 1:2 of hMSCs to rACs) and cultured under chondrogenic conditions for 28 days. The results demonstrated that newly synthesized cartilaginous extracellular matrix (ECM) and type II collagen (col-2) gene signal were upregulated with greater hMSC ratios and longer culture periods. However, a specific col-2 gene probe for human was found only in single hMSC group but absent in all co-culture groups, which indicate that the enhanced cartilaginous phenotype originated from the co-cultured rACs. Osseous phenotype was histologically detected only in the 2:1 group on day 28; and xenogenic osteocalcin assay showed that it originated from hMSCs. This suggests that variations in the ratios of co-cultured hMSC and rAC regulated the cartilaginous and osseous phenotype as well as the differentiation of hMSCs in alginate constructs. The study provides new insights into the role of cell-cell interactions in regulating both cell differentiation and cell function and highlights the importance of developing appropriate differentiation protocols for tissue engineering therapies.