Digitalization, external knowledge sourcing, and service innovation in SMEs

This study examines the impact of digitalization on service innovation performance in Small and Medium-sized Enterprises (SMEs), focusing on how external search breadth moderates this relationship. The goal is to understand how digital transformation and external knowledge sourcing interact to influence innovation outcomes. The study is based on a quantitative analysis of a survey conducted with 489 Canadian SMEs. Probit regression models are used to examine the curvilinear (inverted U-shaped) relationship between digitalization and service innovation, and how this changes when external search breadth is introduced as a moderating variable. The results confirm an inverted U-shaped relationship between digitalization and service innovation in SMEs. However, when external search breadth is high, the relationship changes to a U-shape, indicating that digitalization’s impact on innovation depends on the extent of external knowledge sourcing. Digitalization enhances service innovation but shows diminishing returns when over-applied without appropriate external search breadth. The study’s findings are based on a sample of Canadian SMEs, limiting the generalizability to other contexts. Future research could explore longitudinal data to assess changes over time. SME managers should balance their investments in digitalization with external knowledge sourcing to maximize innovation performance, avoiding over-reliance on one approach. This study extends the literature by providing empirical evidence on the dual effect of digitalization and external search breadth on service innovation, specifically in SMEs. It introduces the concept of a shape-flip in the relationship between digitalization and innovation, contingent on external knowledge sourcing, a novel contribution to the field.