The fused gene encodes a serine/threonine kinase involved in Hedgehog signal transduction during Drosophila embryo and larval imaginal disc development. Additionally, fused mutant females exhibit reduced fecundity that we report here to be associated with defects in three aspects of egg chamber formation: encapsulation of germline cysts by prefollicular cells in the germarium, interfollicular stalk morphogenesis and oocyte posterior positioning. Using clonal analysis we show that fused is required cell autonomously in prefollicular and pre-stalk cells to control their participation in these aspects of egg chamber formation. In contrast to what has been found for Hedgehog and other known components of Hedgehog signal transduction, we show that fused does not play a role in the regulation of somatic stem cell proliferation. However, genetic interaction studies, as well as the analysis of the effects of a partial reduction in Hedgehog signaling in the ovary, indicate that fused acts in the classical genetic pathway for Hedgehog signal transduction which is necessary for somatic cell differentiation during egg chamber formation. Therefore, we propose a model in which Hedgehog signals at least twice in germarial somatic cells: first, through a fused-independent pathway to control somatic stem cell proliferation; and second, through a classical fused-dependent pathway to regulate prefollicular cell differentiation.