Control of tumor development by surrounding normal cells has been suggested by a number of in vitro studies. In vivo, tumorigenicity of ras-transformed primary keratinocytes can be suppressed by addition of normal dermal fibroblasts. Here, we report that dermal fibroblasts produce a diffusible inhibitory factor belonging to the transforming growth factor beta (TGF-beta) family and possibly corresponding to TGF-beta 3. This factor can suppress growth of ras-transformed primary keratinocytes in culture and after injection into mice. As with primary cells, tumorigenicity of a ras-transformed, TGF-beta-sensitive keratinocyte line is substantially inhibited by adding dermal fibroblasts, leading to the formation of much smaller and differentiated tumors. Introduction of an intact E1a oncogene into these cells induces concomitant resistance to TGF-beta, to the effect of dermal-fibroblast inhibitory factor, and to dermal-fibroblast tumor suppression. Similar results are obtained with a transformation-deficient truncated E1a mutant, which binds to a reduced subset of cellular proteins (including the retinoblastoma gene product). Thus, genetic events such as those elicited by E1a transformation enable keratinocytes to escape from the inhibitory influences of a normal cellular environment and lead, together with ras transformation, to skin tumor development.