This study examines the effects of firm heterogeneity on foreign-owned enterprises’ (FOEs) choices regarding serving the local market, undertaking assembly exports or undertaking ordinary exports. It also investigates the effects of serving these markets on productivity. Using a detailed firm–transaction level matched data set of FOEs in China covering 2000–07, the first-stage estimation of propensity score matching (PSM) method reveals that less productive FOEs tend to undertake assembly exports, and this effect is particularly relevant to those located in inland regions. By contrast, more productive FOEs are likely to serve domestic markets or undertake ordinary exports. Other firm characteristics also exhibit diverse influences on market choices. Export-oriented FOEs, particularly those undertaking assembly exports, experience lower productivity growth than that of local market-oriented FOEs. This suggests that the effects of local market competition do result in substantial enhancement of the productivity of FOEs in China. This pattern is mainly exhibited by FOEs in inland regions, whereas FOEs undertaking ordinary exports in coastal regions might have somewhat higher total factor productivity (TFP) growth than their local market-oriented counterparts. Among export-oriented FOEs, exporting more product value—whether assembly or ordinary exports—has a positive influence on productivity.