The impact of innovation capabilities on SME performance in emerging markets: Evidence from Indonesia

Small and medium enterprises (SMEs) are key drivers of economic growth in emerging markets; however, their performance is often constrained by limited resources, technology gaps, and low innovation capabilities. While innovation capability is widely recognized as a determinant of business success, its influence on SME performance in emerging economies remains underexplored. This study examines the effect of three dimensions of innovation capability—product innovation capability, process innovation capability, and market innovation capability—on the performance of SMEs in the manufacturing subsectors of East Java, Indonesia. A quantitative research design was employed, and data were collected from 160 SMEs using purposive sampling. Structured questionnaires were used to obtain responses, and the data were analysed using the Partial Least Squares Structural Equation Modelling (PLS-SEM) approach. The findings reveal that process innovation capability (β = 0.290, p < 0.05) and market innovation capability (β = 0.414, p < 0.05) have a significant positive impact on SME performance, highlighting the importance of internal process efficiency and responsiveness to market demands. In contrast, product innovation capability shows no significant effect (β = 0.049, p > 0.05), suggesting that new product development is not yet a primary driver of performance in this context. Theoretically, this study extends the dynamic capabilities framework within the context of emerging-market SMEs. Practically, it highlights the importance of strategic alignment between operational processes and market orientation to strengthen competitiveness, sustain profitability, and achieve long-term business resilience. These findings offer valuable implications for SME owners, policymakers, and support institutions aiming to foster innovation-driven growth within developing economies.