The Impact of Knowledge Management Strategy on Indonesian MSMEs’ Innovation and Performance Dewangga Wisnu #1 , Achmad Nizar Hidayanto #2 , Ika Alfina #3 # Faculty of Computer Science, Universitas Indonesia Kampus UI Depok, Indonesia 16424 1 dewangga.wisnu@ui.ac.id 2 achmad.nizar@cs.ui.ac.id 3 ika.alfina@cs.ui.ac.id Abstract—Micro, small, and medium enterprises (MSMEs) play a significant role in strengthening the national economy in a worldwide scale. However, in the near future the competition between MSMEs and corporation will be more intense than ever. Therefore, MSMEs need to grow and develop competitive advantages. These advantages could be achieved if the organizations succeed to improve their performance and ability to innovate. This research aims to analyze the relationship among knowledge management (KM) strategy (codification and personalization), innovation and performance in Indonesian MSMEs. The result of this study showed that KM strategy influences SMSEs’ innovation both quality and quantity. Our research also showed that KM strategy influences organizational performance, both directly and indirectly through the improvement of innovation. Keywords— Knowledge Management Strategy, Codification, Personalization, Innovation, Organizational Performance, Micro Small Medium Enterprises (MSMEs) I. INTRODUCTION Worldwide, small and medium-sized enterprises (SMEs) play a significant role in strengthening national economies. They contribute enormously through offering new jobs, increasing technological improvements and competitiveness, and providing more options of services and products (Azyabi et al., 2012). Based on data published by the Ministry of Cooperatives and SMEs of the Republic of Indonesia, one of the greatest contributions of gross domestic product (GDP) in Indonesia comes from micro, small, and medium enterprises (MSMEs) that is equal to 59.08% of Indonesia's GDP in 2012. The number of micro enterprises in Indonesia is a business unit with the greatest number in 2012, which is 98.79% of the total number of MSMEs in Indonesia (Kemenkop UKM, 2013). The existence of a large number of MSMEs, which spread to remote regions, is a real economic strength in the national economic structures. MSMEs are able to absorb as many as 90,896,270 people of labour. This indicates that 97.22% of the 93,491,243 number of national employees working in the MSME sector (Kemenkop UKM, 2013). High employment levels have an impact on the labour market stability guarantees, suppress rising unemployment, a rise of new entrepreneurs the means, and the growth of national entrepreneurs and independent. In the future, competition among MSMEs with large firms will be intense. Therefore, MSMEs should grow up and have a competitive advantage. Competitive advantage can be achieved, one of them through the capability of organization in managing its knowledge (Zack, 1999). Thus knowledge management (KM) is one of the important competitive advantages for a company (Issa and Haddad, 2008). Zack (1999) states that knowledge as a critical resource and it has encouraged managers to give greater attention to company’s knowledge management strategy (KM strategy) (Choi et al., 2007). The study related to the relationship of knowledge management strategies and their impact on MSMEs has not been much done. Therefore, more research on the strategy of knowledge management in SMEs using either a theoretical or a practical point of view is needed (Azyabi et al., 2012). In this study, we aim to test the relationship between knowledge management strategy to quantity and quality of innovation and its impact on the performance of MSMEs in Indonesia. II. LITERATURE REVIEW A. Micro, Small,and Medium Enterprises According to the World Bank's (Nichter and Goldmark, 2009), a small business is defined as the company that has less than 50 employees, with sales of at least 50% of the entire outputs or products generated by these small businesses. In Indonesia, the MSMEs are governed under the Act No. 20 of 2008 on micro, small and medium enterprises (MSMEs). According to this act, the enterprises are classified as micro, small or medium according to their asset and income as can be seen in Table 1. Table 1 MSMEs criteria based on asset and income No. Classification Criteria Asset Income 1 Micro enterprises ≤ 50 million ≤ 300 million 2 Small enterprises >50 million -500 juta >300 million- 2,5 billion 3 Medium enterprises >500 million -10 billion >2,5 billion - 50 billion Sources: Act 20 of 2008 Chapter IV of Article 6 (Kemenkop UKM, 2012)