Small and Medium Enterprises (SMEs), the backbone of the economy, significantly benefit from Knowledge Management (KM). However, the extant literature has little empirical support for this statement. Using the literature review, this paper has developed KM instrument to test a conceptual model linking KM and innovation using regression analysis and structural equation modeling technique. Primary data was collected from SMEs of three industries i.e., software, pharmaceutical and textiles, in North India. The study confirmed the relationship between adoption of KM practices and innovation strategies in the selected SMEs. The findings of the study also revealed that the use of KM practices provides the ability to make use of information flowing into an organization to improve organizational performance, facilitate innovation and create sustainable competitive advantage.

Small and Medium Enterprises (SMEs) are an important part of modern economies, providing employment, generating innovation, creating wealth, reducing poverty, enhancing standard of living and contributing to the areas in which they operate. The strength of SMEs lies in motivation, internal networking, tacit knowledge in unique skills, shorter informal communication, less bureaucracy and greater proximity to market (Desouza and Awazu, 2006). But SMEs face resource, finance and skills scarcity and managers often do not have enough managerial expertise and organizational capabilities, which imply poor strategic business planning and human resource management (Balestrin et al., 2008; and Cocca and Alberti, 2010). KM implementation is said to be the best way to overcome these problems and improve SMEs’ ability in innovation and organizational performance (Choi, 2002; Asoh et al., 2007; Bierly and Daly, 2007; Brachos et al., 2007; Mohannak 2007; Timonen and Ylitalo 2007; Chang and Lee, 2008; Ho, 2008; Chen and Huang, 2009; Jiang and Li, 2009; Kim and Gong, 2009; Liao et al., 2009; Sáenz, 2009; Yang , 2009; and Zack et al., 2009). Knowledge Management (KM) practices in SMEs also help overcome the problem regarding lack of resources, peculiar management problems and high employee turnover rates (Kureshi, 2009). KM provides the means for SMEs to overcome poor business environment and to change the complex business environment to be manageable. KM practices help to remove resource constraints, decrease cost of products and create innovative applications for mature products that help SMEs to move ahead of the competitors (Laere and Heene 2003).

Knowledge Management Journal, Knowledge Management, Innovation, Structural Equation, Small and Medium Enterprises (SMEs), Knowledge Management (KM), Average Variance Extracted (AVE), Modeling Approach.