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Based on survey data about firms in Mexico this paper investigates the determinants of innovation, and the linkages between innovation and productivity in the services sector. We applied a three-stage Crépon-Duguet-Mairesse (CDM) econometric model; the use of manufacturing firms as benchmark helped to better appreciate our findings. The paper identified that a series of structural, performance, and behavioral factors increase a firm's propensity to invest in innovation, but some differences arise between services and manufacturing firms. Intensive investment in innovation leads to superior innovation performance, while innovation output has a positive impact on labor productivity.JEL classification: L8, O12, O14, O31, O33, O38, O40