The differentiation of connective tissue outgrowths of adult bone marrow in response to the organic matrix of bone was observed in tissue culture by correlated histologic, electron microscopic, biochemical, and radioisotope-labeling methods. On a substratum of bone matrix gelatin, myelogenous cells degenerate and disappear while stromal and perivascular cells proliferate and differentiate into mesenchymal-type, monocytoid, and giant cells. From primary cultures of bone marrow cells on bone matrix, cartilage differentiates in isolated areas but only in small islets. With continuous subculture through 25 generations, the proportions of two functionally different populations of chondrogenetic and matrix-resorbing cells gradually emerge. Up to the time of the ninth generation of subculture, the chondrogenetic population predominates. After the 14th to the 25th generation, clones of matrix-resorbing large monocytoid cells predominate and rapidly digest the matrix substratum. Measurements of 35S uptake demonstrate that control cultures of muscle-derived mesenchymal-type cells produce about twice as much cartilage as marrow-derived mesenchymal-type cells. A decline in the chondrogenetic cell population and corresponding rise in the matrix-resorbing cell population is demonstrable by a progressive increase in the quantity of hydroxyproline-containing peptides in the culture medium. This decline is not attributable to conditions in culture because there was progressive loss of chondrogenetic activity of the eighth and 20th passage even when the cells were transplanted in diffusion chambers back into an isologous host. The problem is how to account for the competence of marrow stromal cells to differentiate into bone without bone matrix in vivo but not in vitro. Mixed cultures of muscle and marrow outgrowths produce only half as much cartilage (measured by 36S-uptake/microgramDNA in the system) as muscle outgrowths alone. These observations suggest that a bone marrow-derived matrix-resorbing cell population, by some unknown mechanism, inhibits proliferation of cartilage-bone precursor cell populations. The nature of the inhibition requires investigation by detailed biochemical analyses of marrow cell culture media and chemical extracts of whole bone marrow tissue.