Embryonic stem (ES) cells represent a possible source of islet tissue for the treatment of diabetes. Achieving this goal will require a detailed understanding of how the transcription factor cascade initiated by the homeodomain transcription factor Pdx1 culminates in pancreatic beta-cell development. Here we describe a genetic approach that enables fine control of Pdx1 transcriptional activity during endoderm differentiation of mouse and human ES cell. By activating an exogenous Pdx1VP16 protein in populations of cells enriched in definitive endoderm we show a distinct lineage-dependent requirement for this transcription factor's activity. Mimicking the natural biphasic pattern of Pdx1 expression was necessary to induce an endocrine pancreas-like cell phenotype, in which 30% of the cells were beta-cell-like. Cell markers consistent with the different beta-cell differentiation stages appeared in a sequential order following the natural pattern of pancreatic development. Furthermore, in mouse ES-derived cultures the differentiated beta-like cells secreted C-peptide (insulin) in response to KCl and 3-isobutyl-1-methylxanthine, suggesting that following a natural path of development in vitro represents the best approach to generate functional pancreatic cells. Together these results reveal for the first time a significant effect of the timed expression of Pdx1 on the non-beta-cells in the developing endocrine pancreas. Collectively, we show that this method of in vitro differentiation provides a template for inducing and studying ES cell differentiation into insulin-secreting cells.