Epithelial progenitor cells in skin give rise to multiple lineages, comprising the hair follicle, an associated sebaceous gland, and overlying epidermis; however, the signals that regulate sebocyte development are poorly understood. We tested the potential involvement of the Hedgehog pathway in sebaceous gland development using transgenes designed to either block or stimulate Hedgehog signaling in cutaneous keratinocytes in vivo. Whereas inhibition of the Hedgehog pathway selectively suppressed sebocyte development, Hedgehog pathway activation led to a striking increase both in size and number of sebaceous glands. Remarkably, ectopic Hedgehog signaling also triggered the formation of sebaceous glands from footpad epidermis, in regions normally devoid of hair follicles and associated structures. These ectopic sebaceous glands expressed molecular markers of sebocyte differentiation and were functional, secreting their contents directly onto the skin's surface instead of into a hair canal. The Hedgehog pathway thus plays a key role in sebocyte cell fate decisions and is a potential target for treatment of skin disorders linked to abnormal sebaceous gland function, such as acne.