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Bone morphogenetic protein 3 (BMP3) is a potent osteoinductive growth factor belonging to the TGF-beta superfamily. In this study, we engineered a recombinant BMP3 protein to include an auxiliary collagen-targeting domain derived from von Willebrand coagulation factor (vWF). The collagen-targeted BMP3 fusion protein (rhBMP3-C) was expressed in E. coli, purified from bacterial inclusion bodies, renatured under controlled redox conditions, and assayed for biological activity in vitro and in vivo. The renatured rhBMP3-C fusion protein bound tightly to collagen matrices and inhibited DNA synthesis in normal rat calvaria cells and in two out of three human osteosarcoma cell lines tested. Alkaline phosphatase activity was increased in rat calvarial cells and was decreased in osteosarcoma cells in vitro in a dose-dependent manner. Collagen sponges impregnated with rhBMP3-C and implanted subcutaneously in Fischer-344 rats induced dose-dependent dystrophic calcification of the collagen matrix, with no evidence of ectopic bone formation. However, local injection of rhBMP3-C infused in a collagen suspension induced new bone formation on the periosteal surface of rat calvaria. Finally, in a rat cranial defect model, surgical implantation of rhBMP3-C arrayed on either collagen sponges or on porous ceramics coated with Type I collagen exhibited marked osteoinductive properties. Taken together, these results demonstrate the feasibility of engineering and manufacturing targeted-BMPs which exhibit an integral gain-of-function that may be exploited to therapeutic advantage in (i) the enhancement of effective local concentrations, (ii) the prevention of systemic biodistribution and side effects, and (iii) the design of improved osteoinductive matrices.