Cytokines of the TGF-beta superfamily act through an evolutionarily conserved signaling pathway to elicit a diverse range of biological responses in vertebrates as well as invertebrates. Drosophila has proved to be a powerful system to unravel the profound complexities underlying the regulation of this superficially simple signaling system for two reasons--the availability of sophisticated genetic tools and the restricted number of core signaling components compared to vertebrates. A BMP signaling pathway in Drosophila that regulates growth, differentiation and morphogenesis of the embryo and the larva has been extensively characterized. This work has provided major insights into how gradients of secreted proteins can be established and maintained in vivo, allowing a single ligand to induce multiple cell fates rather than function as an on-off switch. More recently, an activin signaling pathway has also been delineated that is required for growth and neuronal function during development. This review provides an overview of TGF-beta signaling in Drosophila with emphasis on the extensive modulation of signaling activity both within and outside the cell, that enables ligands to trigger specific and context-dependent effects.