The Role of Innovation Capability in Enhancing SME Performance: Insights from Nepal

Abstract

In the face of globalization and rapid technological change, small and medium-sized enterprises (SMEs) in Nepal are facing increasing challenge in maintaining competitiveness, due to limited resources, weak technological adoption and market constraints despite their vital role in economic growth, employment and poverty reduction. Enterprises that continuously introduce new ideas, search opportunities, improve product and services and adapt market needs despite of the constraints are more likely to achieve growth, competitiveness and sustainability. Innovation capability (IC) defined as a firm’s ability to transform ides into valuable output, is a key driver of performance. However, its role in Nepalese SMEs remains underexplored, necessitating focused investigation. This study examines how IC influences the performance of SMEs in Nepal, particularly in enhancing the competitiveness and business outcomes. The study employs a cross-sectional quantitative design, collecting data from 384 entrepreneurs, owners and managers in Kathmandu Valley using a structured questionnaire and purposive sampling. Data were analyzed using descriptive statistics and PLS-SEM with reliability and validity assessed and bootstrapping applied for hypothesis testing. The study finds that marketing innovation significantly improves SME performance, while product and process innovation have positive but insignificant effects and organization innovation shows a negative impact. Overall, IC has a moderate influence, with marketing innovation as the key driver of business success. The study concludes that IC is vital for improving SME performance in Nepal, with marketing innovation plays a dominant role, while other dimension shows mixed effects. Strengthening broader innovation practices and supportive ecosystems is crucial for improving competitiveness and long-term growth of SMEs in Nepal.