1. Introduction
Due to the increasing trend of globalization, the ways of doing business have drastically changed. The market scenario is transforming whereby customers’ needs and wants are changing, the rivalry between competitors is getting stronger, and new technological systems are being implemented. All these factors are causing the environment to become aggressive, which makes it hard to maintain its growth and competitive advantage. Nowadays, traditional business models are no longer competitive in the long term and need to innovate. Therefore, the firms who will survive in the market are those who will provide real value for their consumer through an innovative business model created on a sustainable basis [
1]. More importantly, a necessity has been developed for the firms to improve innovation in order to sustain the business environment [
2]. In other words, the business market is changing constantly due to several external factors [
3]. The capability of organizations to be responsive to these changes can lead to success in the current business situation. To fulfill customer needs, firms have to develop innovative processes to improve products and services, which would lead to customer satisfaction and firm competitiveness. This activity requires innovation and is an integral part of the firm’s sustained growth and success in a dynamic environment [
3]. Innovation and sustainability form an important link in the pursuit of environmental, economic, and social development. Innovation has been seen as an important tool for achieving sustainability [
4]. Plentiful attention has been given to the concept of innovation in different business fields [
5]. For instance, different scholars recognize innovation as important to ensure improved firm performance, profitability, and long-term survival in the business market [
5,
6]. The firms that possess a high capacity to implement the innovation are considered to be risk-taking, proactive, supporting the notion of new ideas, and constructing new business strategies [
7]. As a result, innovation is the root cause of increased business performance [
8,
9]. Hence, some scholars have confirmed in their studies that innovation is directly linked with performance and a competitive edge [
10,
11,
12].
Owing to the increasing trend in global competition, organizations must adopt more sustainable practices that are aligned with prevailing environmental conditions [
13]. Firm performance has a significant impact on the development and economic growth of countries. Firm performance is regarded as the business’s accomplishment in the market. Nowadays, firm performance is one of the critical issues for all organizations across the world because they face rapid competition and globalization. Sustaining a SME’s performance is significant and is still attracts the attention of many researchers; even today, it is still compelling due to the emerging global competition and sustainable growth in the context of developing countries [
14]. However, following the dynamic characteristic of the business market, some researchers have examined the moderating role of the external environment among innovation and firm performance [
15,
16,
17]. Moreover, researchers have attempted to discern how certain environmental factors impact innovation and performance. As the market continuously changes, the current products and services become outdated. Therefore, firms must strive to introduce new products based on the market demand to limit the threat from their competitors and product shortage. This would go a long way in strengthening the company’s position. Innovation allows firms to act proactively and strive for new ways to attain the market demands [
13].
The business environment in which companies are operating in now is highly diverse and uncertain. Therefore, SMEs are required to incorporate innovation to synchronize with the changing trend and move parallel with the market. To avail the opportunity in the new business, environment firms have to generate or improve their existing products. This indicates a strong commitment towards organizational success and enhances firm competitiveness. Another implication of innovation is that it makes SMEs knowledge-based enterprises and promotes the adoption of modern technologies that helps them to tackle external components. This goal can be achieved by the sharing of new innovative ideas in the organization. It should be flexible enough to mold its systems for the betterment of the firm and shape the company future’s direction.
SMEs are regarded as the economic engine and pillar of economic development in every economy. In developing countries, the economic growth mostly depends on the performance of SMEs. Despite the significant economic support and contribution headed for development, SMEs’ performance in developing countries remains below the expectation level [
18]. In Pakistan, the situation is somewhat similar to other developing countries. Pakistani SMEs are striving for smooth economic growth and business sustainability. For business survival and growth, the SMEs in Pakistan have to develop the ability to introduce innovation. These SMEs are required to exploit the opportunity in the market on the basis of innovation to cope with the dynamic environment [
19].
In the current literature, the impact of innovation on firm performance has been widely acknowledged [
20,
21]. However, there is no consensus on the nature of the relationship, i.e., a positive or negative impact of innovation on firm performance. For firms, innovation can be the source of cash flow. Furthermore, firms require massive investments for innovation activities and long periods of time to realize the profit from the innovation [
22]. In the management discipline, different terminology is used for innovation, which explains the inconsistent relationship between innovation and firm performance [
23,
24,
25,
26].
Moreover, prior scholars have found that organizational innovation is highly critical not only for large corporations but also for SMEs [
18]. Innovation has been classified as a crucial element for firms’ wealth generation [
27]. The role of innovation is considered quite instrumental in augmenting firms’ performance [
28]. Studies have shown that the external environment influences organizational performance [
29]. Empirical evidence reveals that the external environment is, directly and indirectly, related to organizational performance [
30,
31]. It has been demonstrated that external environmental forces and innovation could be the destructive elements that may harm the SMEs’ performance if firms do not plan and organize efficiently [
32]. It is postulated that social, economic, and environmental constraints are not just analytical concepts but are the key aspects for the alignment of the business model and strategies of the firm [
32]. Therefore, this study objectively focuses on how innovation influences an SME’s performance and how the external environment moderates this relationship.
Based on the above discussion, this paper aims to analyze the relationship between the external environment, innovation, and firm performance. The model has been constructed to examine the moderation of the external environment. This study will contribute to the body of knowledge on this topic and provide clarification on the role of the external environment. Ultimately, the findings will demonstrate how innovation is important for firms to keep running their businesses in a highly intense market.
5. Conclusions
This study objectively tested the relationship between innovation, the external environment, and performance of Pakistani SMEs. To accomplish these objectives, we tested two main hypotheses. In the first hypothesis, H
1, we examined the direct relationship between innovation and SME performance. In the second hypothesis, H
2, we tested whether the external environment moderates the association between innovation and an SME’s performance. Acceptance of H
1 indicates that innovation is regarded as one of the crucial abilities of SMEs to help them to gain a competitive advantage. The results of our current study postulate that there is a significant positive correlation between innovation and performance. Current findings are consistent with previous research on this topic [
2,
23,
24,
49]. Therefore, the SMEs that want to gain competitiveness must focus on the innovation activities related to products, processes, services, and marketing [
73]. Consequently, SMEs can gain a higher market share based on the uniqueness of their innovation strategy, which should aim to provide higher value to customers [
74]. Hence, a firm’s growth may become higher as product demand arises due to innovative activities. The findings of this study align with previous studies that show how innovation has a positive impact on a firm’s performance [
44,
46,
75,
76]. Especially, a firm can increase its profits, return on sales, expand market share, and meet customer satisfaction levels by applying innovation throughout the organization. This will result in innovative products and services [
77,
78]. Innovation helps organizations in achieving sustainable growth. Innovation leads to the development of new management strategies that help solve problems and redesign the production line faster than its competitors.
This study also enriches the literature stream by testing the moderating role of the external environment on the relationship between innovation and SME performance. The hypothesis testing results revealed the positive nexus among innovation and SME performance, but the relationship between innovation and SME performance intensity changes. In a pressurized environment, external factors cause firms to be highly active to perform and compete. In other words, firms that are exposed to a dynamic environment are capable of bringing changes into the organization more quickly by innovation. Therefore, these firms can gain an edge over their competitors. The product and services offering surpasses its competitors. Such firms can access customer information rapidly and meet their criteria efficiently and effectively. These findings are consistent with the views of [
79], who stated that the rate of innovation is high in dynamic environments. In this study, a moderating analysis was done to examine the relationship between the two variables when a moderator is present. Thus, the external environment was assumed to change the strength of the relationship between innovation and firm performance [
80].
The findings show that the relationship between these variables was enhanced in the turbulent environment [
81]. Moreover, the findings also demonstrate that the performance of firms is greater and the level of innovation is higher where there is intense competition [
82]. Firms that have a higher capability to innovate when compared to another firm’s resources are more effective in responding to environmental changes and developing new capabilities [
46,
83]. Nowadays, the core aims of SMEs are not only to innovate, survive, or be profitable in a dynamic business environment, but also to strive for innovative new markets and remain in the competition. On the one hand, current findings support a previous researcher who argues that innovation increases the risk to one’s investments [
84]. However, at the same time, our findings support previous research that postulates that when uncertainty and changes in the environment are high, there are more opportunities for the firm to utilize these opportunities by engaging in innovation activities. Ultimately, these activities will enhance the learning capabilities of firms [
85].
The current research emphasized the significant impact of innovation and the external environment on an SME’s performance. These findings will undoubtedly be useful to academia and practitioners in their future decisions. Previous studies have mostly focused on large firms and developed economies to test these variables. In contrast, our current study focused on SMEs in a developing country and thus fills a gap in the literature. This study has implications for policy-makers since it provides an insight into the way that SMEs can support their innovation activities using their resources. SME owners/managers need to ensure that their firms provide clients with products and services of unique benefits, offer innovative ideas and solutions to a client’s problems, and encourage employees to look for novel ways of problem-solving. This could assist policy-makers in their issuance of regulations that urge market practices to support the maximization of innovation in SMEs. More importantly, it could improve the relationship between government entities and industrial SMEs as the pillar of economic development of the country. The government bodies should provide financial instruments to support innovation, such as R&D framework programs and structural funds, to improve the business environment and thus the functionality of the SMEs. Finally, the outcome of this study is expected to be used by the Pakistani government and agencies to develop the best strategies to enhance the textile industry SMEs in Pakistan, in conjunction with initiatives aimed at increasing cooperation with foreign companies to increase their experiences and support their competencies to exploit externally generated knowledge.
6. Limitation and Recommendation
Despite the major contributions of our research, it has a few limitations that must be taken into consideration. Firstly, the data were gathered by a self-administered survey technique from a single respondent in an organization that could potentially bias our results. Thus, a goal for future studies would be to focus on collecting data from multiple informants in an organization. Since the coefficient of determination (R2 value) accounted for 40.6% of the variance in the endogenous variable, namely SME performance, there are some other factors or variables that may contribute to the remaining variance in the endogenous variable. Therefore, future studies would stand to benefit by adding some other independent variables, mediation, or another moderator in the current model. The present study was cross-sectional. For greater knowledge, generalizability, and understanding of the relationships, future studies could focus on longitudinal data and comparative research related to the current variables (innovation, the external environment, and SME performance). Furthermore, similar studies can be conducted in other sectors and developing countries for greater generalizability of the findings. Finally, this study focused on SME performance using a general perspective, i.e., from an economic standpoint. In this regard, future research could focus on other aspects of performance, such as social and environmental concerns.
For practitioners, this model and the outcomes of this study may serve as a useful guide to all stakeholders, including policymakers, relevant administrative departments, and individual organizations and professionals. The results of this study may lead to improved performance and enhanced innovation by mitigating the impact of a disturbance in the external environment. For academia, this research is significant as it may become the basis for the inclusion of other environmental factors (political stability, social and demographic influence, etc.) to further expand the model. Additional environmental influences may lead to more clarity and broad-based generalization of this model.