SummaryThe notion of strategic purchasing has gained increasing currency in the global health policy discourse. It is believed that an active prudent purchaser is able to act in the best interest of both government and consumers as a third party negotiating with providers for cost‐effective care. It would be wrong, however, to assume that the formation of a third‐party purchaser automatically leads to such desired outcomes. A variety of agency problems relating to incompetence often prevent purchasers from fulfilling their mandates, aggravating cost inflation. This study provides an alternative explanation for the rapid cost inflation in the Chinese health system, by focusing on the unique role played by the social health insurance administration. Provincial‐level panel data analysis reveals that misaligned bureaucratic incentives and limited administrative capacity of the social health insurance administration contribute significantly to rapidly escalating costs. This study argues that despite the merit of the notion of third‐party strategic purchasing, it must not be forgotten that effective purchasing hinges on certain crucial prerequisites that may not necessarily be present in reality. Appropriate alignment of the social health insurance administration's organizational mandates and development of its capacity is essential to China's move towards strategic purchasing of health services.