Background Sensory neuron diversity ensures optimal detection of the external world and is a hallmark of sensory systems. An extreme example is the olfactory system, as individual olfactory receptor neurons (ORNs) adopt unique sensory identities by typically expressing a single receptor gene from a large genomic repertoire. In Drosophila, about 50 different ORN classes are generated from a field of precursor cells, giving rise to spatially restricted and distinct clusters of ORNs on the olfactory appendages. Developmental strategies spawning ORN diversity from an initially homogeneous population of precursors are largely unknown. Results Here we unravel the nested and binary logic of the combinatorial code that patterns the decision landscape of precursor states underlying ORN diversity in the Drosophila olfactory system. The transcription factor Rotund (Rn) is a critical component of this code that is expressed in a subset of ORN precursors. Addition of Rn to preexisting transcription factors that assign zonal identities to precursors on the antenna subdivides each zone and almost exponentially increases ORN diversity by branching off novel precursor fates from default ones within each zone. In rn mutants, rn-positive ORN classes are converted to rn-negative ones in a zone-specific manner. Conclusions We provide a model describing how nested and binary changes in combinations of transcription factors could coordinate and pattern a large number of distinct precursor identities within a population to modulate the level of ORN diversity during development and evolution.