6 Chapter II Literature Review II.1 Introduction The concept of Corporate Social Responsibility (CSR) has gained significant attention in recent years as businesses strive to become more socially responsible and environmentally sustainable (H. Li et al., 2020; Szczanowicz & Saniuk, 2016; Zou et al., 2021). Small and medium-sized enterprises (SMEs) are no exception and have increasingly been encouraged to adopt CSR practices. While the benefits of CSR for larger firms have been well-documented, the impact of CSR on SMEs' financial and environmental performance is not fully understood (Huang et al., 2020; Ortiz-Avram et al., 2018; Sendlhofer, 2020). This literature review aims to explore the relationship between CSR, SMEs' innovativeness, and their financial performance. The review will begin by defining the concept of CSR and discussing its evolution over time. Then, it will examine the role of SMEs in promoting sustainable development and their unique challenges in adopting CSR practices. The review will also focus on SMEs' innovativeness, which has been identified as a key factor in driving CSR adoption and enhancing firm performance. II.2 Corporate Social Responsibility (CSR) in SMEs The increasingly fierce market competition encourages business actors to continue to innovate so that they have a competitive advantage that can be a bargaining value compared to competitors. A growing stream of literature proposes corporate social responsibility (CSR) as one of the ways that can be adopted to achieve product differentiation (Huang et al., 2020; Ortiz-Avram et al., 2018). The concept of corporate social responsibility has been defined in many ways, from a narrow perspective (Jenkins, 2004) to a broad one (Morsing & Spence, 2019), and includes other definitions that emphasize politics (Taliouris, 2018; Valeri, 2013), business (Sendlhofer, 2020) or strategic view (Russo & Perrini, 2010). The various definitions of CSR reflect its complex and 7 evolving nature, which also reflects the increasing pressures businesses face to increase their social responsibilities. The increasing awareness of market participants on environmental and social issues coupled with intense competition in the product market causes two pressures: moral and strategic. Moral pressure is a tool used by stakeholders, such as the green movement, to publicly humiliate companies that behave socially irresponsibly. The strategic emphasis is based on the argument that CSR should be designed and implemented to promote differentiation at the product and company level, and thereby enhance the competitiveness of the company (Hou et al., 2020). Along with the perceived benefits of the company towards the implementation of CSR, even though the benefits of implementing CSR programs occur indirectly, they affect the development of the company's potential in key areas (Yusuf et al., 2023). This raises the question of whether the potential benefits of implementing CSR can occur in SMEs, which have more limited resources than large firms (Fayyaz et al., 2017), and where, because of the capital structure, the main decision makers are most often managers. -owner, that is, the person who makes decisions relating to the use of own capital, and not the capital of others, as in the case of large corporations. Therefore, it is hoped that the activities The activities carried out in SMEs are different from the activities carried out in large companies (Valeri, 2013). The size of the company is not a significant factor in the implementation of CSR programs, this is by the results of research showing that the CSR concept can be applied in the management practice of any scale company (López-Pérez et al., 2017). The results of other studies indicate that due to the limitations experienced by SMEs towards the goals in sustainable development differ significantly from the goals achieved by large companie (Kim & Bhalla, 2022; Stekelorum et al., 2020). With the issue of economies of scale (Ciliberti et al., 2014; Lekan, 2021), it should be borne in mind that small companies may have difficulty in supporting and financing some CSR activities, because the implementation of CSR in SMEs is relatively high (Moraux et al., 2021; Stawicka, 2015), which 8 makes the implementation process more difficult. point out that it is difficult for SME managers to invest in social and environmental management from an economic and competitive point of view, as most clients do not offer to pay more for environmentally friendly products and processes, while CSR activities are often considered the term “business costs without benefits” (Scagnelli et al., 2013). Research by Dincer & Dincer reveals that when making decisions in the area of CSR, managers act under the influence of personal feelings, financial conditions, friends, family, and religion (Moraux et al., 2021; Stawicka, 2015). Furthermore, SME decision makers care about the environment, and go beyond basic requirements when carrying out local CSR activities (Šebestová & Sroka, 2020; Sulistianingsih & Santi, 2023). So that the implementation of CSR in the SME sector is proposed as a concept of sustainable business development which is an important part of global economic growth with a significant contribution of SMEs to the development and economic growth of a region (Elijah & Usaini, 2021; Tambunan, 2008). II.3 Innovation in SMEs Innovation plays a crucial role in the survival and growth of small and medium- sized enterprises (SMEs) (Dwivedi & Pawsey, 2023; Ramdani, Raja, et al., 2022). In today's competitive and dynamic business landscape, SMEs need to embrace innovation to stay relevant. This is particularly important as SMEs are considered the backbone of inclusive growth strategies (Błach et al., 2020; Demirkan et al., 2022). Research suggests that more innovative SMEs tend to be more productive and can offer better working conditions to their employees. Therefore, fostering innovation is not only beneficial for the organization but also for the overall well-being of the workforce. The need for innovation in contemporary enterprises is driven by several factors, including intense competition, rapid technological advancements, and recurring crises (Games, 2020; Rehm & Goel, 2017). To remain resilient in such an 9 environment, SMEs must adapt and innovate. While large corporations often face challenges in implementing radical innovation, SMEs are better suited for incremental innovation and have the flexibility to renew or reinvent their business models. This ability to adapt and evolve is a key advantage for SMEs in their innovation journey. Innovation capability, defined as the organization's ability to transform knowledge and ideas into new products, processes, and systems, is fundamental to SMEs' success. Studies have identified five indicators that contribute to SMEs' innovation practices: "external knowledge," "structure," "leadership," "regeneration," and "employees" (Foreman-Peck, 2013; Nguyen et al., 2020; Qamruzzaman & Jianguo, 2019). These indicators encompass various aspects such as accessing external knowledge sources, having an adaptable organizational structure, strong leadership support for innovation initiatives, fostering a culture of regeneration and continuous improvement, and empowering employees to contribute to innovation efforts. Despite the importance of innovation for SMEs, they face certain challenges in developing innovation capabilities (Fan et al., 2021; Wongsansukcharoen & Thaweepaiboonwong, 2023). Common hurdles include lack of resources, limited skills and expertise, and limited access to external knowledge and networks. However, researchers and experts have identified several recommendations to help SMEs overcome these challenges (Imran et al., 2019; Otache & Usang, 2022). These include investing in employee skills development to enhance their innovative capabilities, building innovation networks and collaborations with external partners, and fostering a culture that encourages and rewards innovation. By implementing these recommendations, SMEs can enhance their innovation potential and increase their chances of long-term success. Innovation takes many forms. However, in this study, innovation is limited to 2 types, namely process innovation and product innovation referring to previous research which narrowed down the 2 innovations because of the limited aspects 10 possessed by SMEs (Löfsten, 2014; Rasheed et al., 2021). Process innovation is a strategy for companies to increase barriers to entry for competitors and gain leadership in the market (Ramdani, Belaid, et al., 2022; Ueasangkomsate & Jangkot, 2019). Process innovations occur within company boundaries and, therefore, are often hidden from competitors (Najib et al., 2021; Simboli et al., 2015). Benner and Tushman (2003) report process innovation as an intangible part of product innovation. Process innovation helps in developing new products with significantly improved technical specifications and functionality compared to existing ones (Hervas-Oliver et al., 2020) and faces the risk of product failure (Arifin & Roosdani, 2021; Ginting & Tampubolon, 2021; Srimarut & Mekhum, 2020). Furthermore, process innovation reduces production costs and this has an impact on the price of the final product (Ginting & Tampubolon, 2021; Kaya, 2022; Rahmah et al., 2020).