Co-culture of hepatocytes or hepatocyte spheroids with the supporting NIH3T3 in a 3D microcapsule formed with a hybrid natural/synthetic matrix has led to enhanced hepatocyte functions. We investigated the mechanism of the functional enhancement in co-culture with respect to the contributions of soluble factors and direct cell-cell interactions. The conditioned media from the co-culture induced higher P450 cytochrome oxidase activity (indicated by EROD assay) in the microencapsulated hepatocytes than the conditioned media from the NIH3T3- or the hepatocytes-alone controls. Conditioned media from physically separated co-culture of hepatocytes-NIH3T3 by a membrane insert reduced the functional enhancement. Among the known stimulators of hepatocyte functions, TGFbeta1 is primarily responsible for the stimulation of hepatocyte functions in this 3D co-culture since the removal of TGFbeta1 by antibody depletion eliminated the functional enhancement and the reconstitution of TGFbeta1 restored the functional enhancement. Activation of latent TGFbeta1 in an extracellular environment were upregulated in co-culture with no observable increase in the TGFbeta1 expression at transcriptional and translational levels. Our data led to an improved understanding of how co-culture enhances hepatocyte functions in vitro and pave the way for further innovations in liver tissue engineering, drug metabolism studies, and other applications that require functional hepatocytes cultured in vitro. (C) 2005 Wiley Periodicals, Inc.