Embryonic stem (ES) cells are a uniquely self-renewing, pluripotent population of cells that must be differentiated before being useful for cell therapy. Since most studies utilize subcutaneous implantation to test the in vivo functionality of ES cell-derived cells, the objective of the current study was to develop an appropriate and clinically relevant in vivo implantation system in which the behavior and tumorigenicity of ES cell-derived cells could be effectively tested in a tissue-specific (orthotopic) site. Male ES cells were differentiated either into osteoblasts or chondrocytes using protocols that were previously developed and published by our laboratory. The differentiated cells were implanted into a burr-hole fracture created in the proximal tibiae of immunocompetent female mice, strain matched to the ES cell line. The ability of the differentiated ES cell-derived cells (bearing the Y chromosome) to incorporate into the newly formed bone was assessed by micro-computed tomography imaging and histochemistry. ES cells differentiated with either osteogenic or chondrogenic medium supplementation formed a soft tissue mass that disrupted the normal bone architecture by 4 weeks after implantation in some mice. In contrast, mice receiving osteoblastic cells that were differentiated in a three-dimensional type 1 collagen gel showed evidence of new bone formation at the defect site without evidence of tumor formation for up to 8 weeks after implantation. In this injury model, type 1 collagen is more effective than medium supplementation at driving more complete differentiation of ES cells, as evidenced by reducing their tumorigenicity. Overall, the current study emphasizes the importance of using an appropriate orthotopic implantation system to effectively test the behavior and tumorigenicity of the cells in vivo.