The epithelial-mesenchymal interactions between keratinocyte stem cells and dermal papilla (DP) cells are crucial for normal development of the hair follicle as well as during hair cycling. During the cyclical regrowth of a new lower follicle, the multipotent hair follicle stem cells are stimulated to proliferate and differentiate through interactions with the underlying mesenchymal DP cells. To characterize the events occurring during the process of epithelial stem cell fate determination, we utilized a coculture system by incubating human hair follicle keratinocyte stem cells with DP cells. Using GeneChip microarrays, we analyzed changes in gene expression within the stem cells upon coculture with the DP over a 5-day time course. A number of important signaling pathways and growth factors were regulated. The hair-specific keratin 6hf (K6hf) gene proved a particularly good marker of hair differentiation, with a 7.9-fold increase in mRNA and resulting increased protein levels. The high expression of K6hf was unique to DP-induced keratinocyte differentiation, since expression of K6hf was not induced by high calcium. Since the beta-catenin signaling pathway has been implicated in hair follicle development, we examined the role of beta-catenin in our system and demonstrated that beta-catenin/lef-1 signaling is required for DP-induced hair differentiation.