The embryonic gut of vertebrates consists of endodermal epithelium, surrounding mesenchyme derived from splanchnic mesoderm and enteric neuronal components derived from neural crest cells. During gut organogenesis, the mesenchyme differentiates into distinct concentric layers around the endodermal epithelium forming the lamina propria, muscularis mucosae, submucosa and lamina muscularis (the smooth muscle layer). The smooth muscle layer and enteric plexus are formed at the outermost part of the gut, always some distance away from the epithelium. How this topographical organization of gut mesenchyme is established is largely unknown. Here we show the following: (1) Endodermal epithelium inhibits differentiation of smooth muscle and enteric neurons in adjacent mesenchyme. (2) Endodermal epithelium activates expression of patched and BMP4 in adjacent non-smooth muscle mesenchyme, which later differentiates into the lamina propria and submucosa. (3) Sonic hedgehog (Shh) is expressed in endodermal epithelium and disruption of Shh-signaling by cyclopamine induces differentiation of smooth muscle and a large number of neurons even in the area adjacent to epithelium. (4) Shh can mimic the effect of endodermal epithelium on the concentric stratification of the gut. Taken together, these data suggest that endoderm-derived Shh is responsible for the patterning across the radial axis of the gut through induction of inner components and inhibition of outer components, such as smooth muscle and enteric neurons.