Seasonally dry, water-limited regions are often co-dominated by distinct herbaceous and woody plant communities with contrasting ecohydrological properties. We investigated the shape of the above-ground net primary productivity (ANPP) response to annual precipitation (Pa) for adjacent grassland and shrubland ecosystems in Southern California, with the goal of understanding the role of these ecohydrological properties on ecosystem function. Our synthesis of observations and modelling demonstrates grassland and shrubland exhibit distinct ANPP-Pa responses that correspond with characteristics of the long-term Pa distribution and mean water balance fluxes. For annual grassland, no ANPP occurs below a ‘precipitation compensation point,’ where bare soil evaporation dominates the water balance, and ANPP saturates above the Pa where deep percolation and runoff contribute to the modelled water balance. For shrubs, ANPP increases at a lower and relatively constant rate across the Pa gradient, while deep percolation and runoff account for a smaller fraction of the modelled water balance. We identify precipitation seasonality, root depth, and water stress sensitivity as the main ecosystem properties controlling these responses. Observed ANPP-Pa responses correspond to notably different patterns of rain-use efficiency (RUE). Grass RUE exceeds shrub RUE over a wide range of typical Pa values, whereas grasses and shrubs achieve a similar RUE in particularly dry or wet years. Inter-annual precipitation variability, and the concomitant effect on ANPP, plays a critical role in maintaining the balance of grass and shrub cover and ecosystem-scale productivity across this landscape. Copyright © 2015 John Wiley & Sons, Ltd.