In Drosophila, ligands of the Unpaired (Upd) family activate the Janus kinase/signal transducers and activators of transcription (JAK/STAT) pathway. The JAK/STAT pathway controls many developmental events, including multiple functions in the ovary. These include an early role in the germarium for specification of stalk cells and a later role in the vitellarium to pattern the follicular epithelium surrounding each cyst. In this latter role, graded JAK/STAT activation specifies three distinct anterior follicular cell fates, suggesting that Upd is a morphogen in this system. Consistent with the JAK/STAT activation pattern in the vitellarium, Upd forms a concentration gradient on the apical surface of the follicular epithelium with a peak at its source, the polar cells. Like many morphogens, signaling and distribution of Upd are regulated by the heparan sulfate proteoglycans (HSPGs) Dally and Dally-like. Mutations in these glypican genes and in heparan sulfate biosynthetic genes result in disruption of JAK/STAT signaling, loss or abnormal formation of the stalk and significant reduction in the accumulation of extracellular Upd. Conversely, forced expression of Dally causes ectopic accumulation of Upd in follicular cells. Furthermore, biochemical studies reveal that Upd and Dally bind each other on the surface of the cell membrane. Our findings demonstrate that Drosophila glypicans regulate formation of the follicular gradient of the Upd morphogen, Upd. Furthermore, we establish the follicular epithelium as a new model for morphogen signaling in complex organ development.