Abstract Beginning in the early 1990’s, grazing lands once held in common were contracted to individual households in the rangeland regions of China. The resulting fragmentation of rangelands has led to ecological and social problems. As China seeks to address intractable poverty and rangeland degradation, attention has turned to rental, or transfer, of contracted grazing land as a market-based approach to re-aggregating grazing land into larger units that support economies of scale. However, given that many pastoral regions still maintain community customary institutions, what the relationship between market mechanisms and local customary institutions should be in rangeland management needs further analysis. This paper applies comparative case studies of two types of relationships between market mechanisms and customary institutions: (1) market mechanisms that replace customary institutions in the case of Axi village, and (2) market mechanisms that are embedded within customary institutions in Xiareer village. This allows contrast of the impacts of differing approaches on livelihoods, livestock production, and wealth differentiation among pastoral households. We found that there is a higher level of livestock mortality, lower livestock productivity, and higher livestock production cost in Axi Village compared to Xiareer Village. In addition, household asset levels are higher and there is less income differentiation in Xiareer Village. It is concluded that embedding market mechanisms within customary institutions has had notable benefits for the herders of Xiareer Village, because it is a better fit to the coupled pastoral social-ecological system. Based on these findings, we argue that in pastoral communities where the rangeland transfer system for contracted grazing land has not yet been implemented, it is critical to reconsider China’s current policy approach to pay greater attention to the innovative management systems being developed in local regions. Instead of considering market-based approaches as oppositional to traditional institutions, options that derive from the interaction of market-based and customary institutions should be considered.