Evaluating the Role of Open Innovation and Circular Economy in Enhancing Organizational Performance: Insights from Batik Small and Medium Enterprises in Banyuwangi, Indonesia

Batik SMEs are key contributors to Indonesia’s heritage and economy. Their inability to fully harness innovative and sustainable practices threatens not only their survival but also their contribution to economic development. However, their path to sustainability is hindered by many limitations in adopting circular economy (CE) principles; a framework widely acknowledged to enhance organizational performance. This study examines and evaluates the application of innovation within Indonesia’s batik SME sector, focusing on the simultaneous impact of open innovation and circular economy principles—an area that has been largely unexplored within this specific sector. Our study analyzes the influence of open innovation and circular economy on organizational performance, measured via simulations among 70 Batik SMEs in Banyuwangi, Indonesia, using Structural Equation Modeling–Partial Least Square (SEM-PLS). The results reveal that while both open innovation and CE enhance performance, some dimensions of CE—such as waste reduction—prove less relevance to the business models of Batik SMEs based on model iteration. Moreover, this includes a discussion about several elimination items within the iteration. These findings suggest that Batik SMEs benefit more from resource optimization and innovation networks than from rigid waste management practices. In conclusion, integrating open innovation with tailored circular economy strategies can improve the operational efficiency and sustainability of Batik SMEs, enabling them to better compete and grow. This research highlights the need for context-specific adaptations of CE principles to ensure their practical impact on different sectors, emphasizing the role of innovation in overcoming resource limitations.