Aims/hypothesisHuman embryonic stem cells (hESCs) and human induced pluripotent stem cells (hIPSCs) offer unique opportunities for regenerative medicine and for the study of mammalian development. However, developing methods to differentiate hESCs/hIPSCs into specific cell types following a natural pathway of development remains a major challenge.MethodsWe used defined culture media to identify signalling pathways controlling the differentiation of hESCs/hIPSCs into pancreatic or hepatic progenitors. This approach avoids the use of feeders, stroma cells or serum, all of which can interfere with experimental outcomes and could preclude future clinical applications.ResultsThis study reveals, for the first time, that activin/TGF-β signalling blocks pancreatic specification induced by retinoic acid while promoting hepatic specification in combination with bone morphogenetic protein and fibroblast growth factor. Using this knowledge, we developed culture systems to differentiate human pluripotent stem cells into near homogenous population of pancreatic and hepatic progenitors displaying functional characteristics specific to their natural counterparts. Finally, functional experiments showed that activin/TGF-β signalling achieves this essential function by controlling the levels of transcription factors necessary for liver and pancreatic development, such as HEX and HLXB9.Conclusion/interpretationOur methods of differentiation provide an advantageous system to model early human endoderm development in vitro, and also represent an important step towards the generation of pancreatic and hepatic cells for clinical applications.Electronic supplementary materialThe online version of this article (doi:10.1007/s00125-012-2687-x) contains peer-reviewed but unedited supplementary material, which is available to authorised users.