AngularJS: factory model not updated in controller

The problem is in the factory you close over model and then you replace model with a new model. This replacement does not affect the original closure--the original model is unchanged and the closure is replaced by a reference to a new instance. Instead of replacing model you have to update the contents of model.

This is exactly why your commented out line works correctly. It updates the contents of model, not model entirely.

function FooCtrl (myFactory1) {
    myFactory1.changeModel();
    this.model1 = myFactory1.model // model1 not updated
}

app.factory('myFactory1', function () {
    var model = {
        foo: 'original'
    };

    function changeModel () {
        model.foo = 'change';
    }

    // esposed API
    return {
        model: model,

        changeModel: function () {
            changeModel();
        }
    };  

});

function FooCtrl (myFactory1) {
    myFactory1.changeModel();
    this.model1 = myFactory1.model // model1 not updated
}

here have updated to be like what you wanted, plus adding comments and labeling your function (on which is factory and which is service) but not touching your FooCtrl. Just your factory1 and factory2

http://jsfiddle.net/eobq064h/2/

app.factory('myFactory2', function TheFactory() {
    var model = {
        foo: 'original'
    };

    // returning a new service instance
    return new TheService();
    // esposed API
    // returning a service with api and a model
    function TheService() {
        var oThis = this;

        oThis.model = model;

        // public methods
        oThis.changeModel = function () {
            changeModel();
        }

        // private methods
        function changeModel() {
            oThis.model.foo = 'changed';
        }
    };  
});