The degree of firm heterogeneity is primarily reflected by the differences in the total factor productivity (TFP). Heterogeneous firms across regions shape the spatial heterogeneity of TFP. Regional TFP heterogeneity is the underlying cause of regional economic growth differences. Based on data on Chinese manufacturing firms in operation during the period 2001–2007, we employ BHC (Baily-Hulten-Campbell) and productivity decomposition methods to analyse the driving forces of regional productivity. As the driving force of domestically-funded firms’ productivity, the effects of technological progress and economies of scale decline steadily. At the same time, effects of innovation transfer rises steadily. In coastal areas of China (Eastern region), the positive impact of foreign direct investment on domestic firms’ TFP is decreasing. However, the positive effect of foreign direct investment is relatively stable in the Central region and Western region. A regional policy approach is therefore proposed based on the empirical analysis of these four effects.