Supraphysiological concentrations of exogenous growth factors are typically required to obtain bone regeneration, and it is unclear why lower levels are not effective. We hypothesized that delivery of bone progenitor cells along with appropriate combinations of growth factors and scaffold characteristics would allow physiological doses of proteins to be used for therapeutic bone regeneration. We tested this hypothesis by measuring bone formation by rat bone marrow stromal cells (BMSCs) transplanted ectopically in SCID mice using alginate hydrogels. The alginate was gamma-irradiated to vary the degradation rate and then covalently modified with RGD-containing peptides to control cell behavior. In the same delivery vehicle, we incorporated bone morphogenetic protein-2 (BMP2) and transforming growth factor-β3 (TGF-β3), either individually or in combination. Individual delivery of BMP2 or TGF-β3 resulted in negligible bone tissue formation up to 22 weeks, regardless of the implant degradation rate. In contrast, when growth factors were delivered together from readily degradable hydrogels, there was significant bone formation by the transplanted BMSCs as early as 6 weeks after implantation. Furthermore, bone formation, which appeared to occur by endochondral ossification, was achieved with the dual growth factor condition at protein concentrations that were more than an order of magnitude less than those reported previously to be necessary for bone formation. These data demonstrate that appropriate combinations of soluble and biomaterial-mediated regulatory signals in cell-based tissue engineering systems can result in both more efficient and more effective tissue regeneration.