Specification of progenitors into the osteoblast lineage is an essential event for skeletogenesis. During endochondral ossification, cells in the perichondrium give rise to osteoblast precursors. Hedgehog (Hh) and bone morphogenetic protein (BMP) are suggested to regulate the commitment of these cells. However, properties of perichondrial cells and regulatory mechanisms of the specification process are still poorly understood. Here, we investigated the machineries by combining a novel organ culture system and single-cell expression analysis with mouse genetics and biochemical analyses. In a metatarsal organ culture reproducing bone collar formation, activation of BMP signaling enhanced the bone collar formation cooperatively with Hh input, whereas the signaling induced ectopic chondrocyte formation in the perichondrium without Hh input. Similar phenotypes were also observed in compound mutant mice, where signaling activities of Hh and BMP were genetically manipulated. Single-cell quantitative RT-PCR analyses showed heterogeneity of perichondrial cells in terms of natural characteristics and responsiveness to Hh input. In vitro analyses revealed that Hh signaling suppressed BMP-induced chondrogenic differentiation; Gli1 inhibited the expression of Sox5, Sox6, and Sox9 (SRY box-containing gene 9) as well as transactivation by Sox9. Indeed, ectopic expression of chondrocyte maker genes were observed in the perichondrium of metatarsals in Gli1(-/-) fetuses, and the phenotype was more severe in Gli1(-/-);Gli2(-/-) newborns. These data suggest that Hh-Gli activators alter the function of BMP to specify perichondrial cells into osteoblasts; the timing of Hh input and its target populations are critical for BMP function.