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Successful innovation is vital for firm survival in modern service industries. This study empirically investigates the effect of customer's interaction with service production on knowledge transferring, and the consequent effect of knowledge transfer on service innovation performance in service sectors. Following an empirical framework, a survey was developed in seven service sectors and data collected from 122 Chinese service firms. Results indicate strong positive relationships between three dimensions of customer interaction and knowledge transfer. Moreover, two of these three positive links are moderated by service climate. Our study also supports that customer knowledge transfer is positive to service innovation performance.