The paper contributes to the understanding of the nature of local knowledge spillovers and their importance for innovation in clusters in developing countries. Using detailed primary data about a cluster of software firms in Montevideo, Uruguay, the paper finds plenty of evidence of the existence of pure unintentional knowledge spillovers. In addition, it supports previous theoretical studies that have contended that there are also many knowledge flows that are to some degree produced purposively by local parties—these flows can be placed somewhere in between pure spillovers and pure market transactions. While the respondents themselves place most value on knowledge flows that are more or less purposively co-produced with customer transactions, a more objective statistical analysis shows that good product/service-innovation performance is associated with intensive use of flows with more pronounced spillover characteristics. The respondents possibly underrate the latter because of their invisibility and spontaneous nature. Heavy use of knowledge flows lying close to the market-transaction side of the spectrum is found to be associated with relatively advanced organizational capability, but not with product innovation. Overall, the findings point towards the relevance of cluster-based policies to promote innovation in a less developed country context. Various policy measures to stimulate the local circulation of knowledge are suggested.