Binding of macrophage colony stimulating factor (M‐CSF) to its receptor (Fms) induces dimerization and activation of the tyrosine kinase domain of the receptor, resulting in autophosphorylation of cytoplasmic tyrosine residues used as docking sites for SH2‐containing signaling proteins that relay growth and development signals. To determine whether a distinct signaling pathway is responsible for the Fms differentiation signal versus the growth signal, we sought new molecules involved in Fms signaling by performing a two‐hybrid screen in yeast using the autophosphorylated cytoplasmic domain of the wild‐type Fms receptor as bait. Clones containing SH2 domains of phospholipase C‐γ2 (PLC‐γ2) were frequently isolated and shown to interact with phosphorylated Tyr721 of the Fms receptor, which is also the binding site of the p85 subunit of phosphatidylinositol 3‐kinase (PI3‐kinase). At variance with previous reports, M‐CSF induced rapid and transient tyrosine phosphorylation of PLC‐γ2 in myeloid FDC‐P1 cells and this activation required the activity of the PI3‐kinase pathway. The Fms Y721F mutation strongly decreased this activation. Moreover, the Fms Y807F mutation decreased both binding and phosphorylation of PLC‐γ2 but not that of p85. Since the Fms Y807F mutation abrogates the differentiation signal when expressed in FDC‐P1 cells and since this phenotype could be reproduced by a specific inhibitor of PLC‐γ, we propose that a balance between the activities of PLC‐γ2 and PI3‐kinase in response to M‐CSF is required for cell differentiation.