Transitioning Towards Circular Economy Practices: The Role of Organizational Capabilities and Environmental Dynamism—Evidence From Indonesia

ABSTRACT Circular economy practices are increasingly recognized as strategic approaches to enhance competitiveness and sustainability. However, the transition to circular business models, particularly concerning internal capabilities and environmental dynamics in small‐ and medium‐sized enterprises (SMEs), has not been sufficiently explored. This study examines the impact of organizational agility and environmental dynamism on circular economy practices among Indonesian SMEs. Data from 207 companies (828 respondents) were analyzed using structural equation modeling. Results show that both organizational agility and environmental dynamism significantly drive strategic changes towards circular economy practices. Organizational agility positively influences circular product innovation and production processes, while environmental dynamism has a notably positive impact on recycling initiatives. The adoption of circular business models mediates organizational agility and environmental dynamism towards circular economy practices (circular product innovation, circular production practices, and recycling practices). This research enhances our understanding of how organizational adaptability and environmental factors promote circular business models in SMEs. This study integrates dynamic capability and institutional theory through a comprehensive model to enhance the circular economy literature, especially in the SME sector. In addition, the research findings offer valuable insights for policymakers and business leaders implementing circular economy principles in the SME sector, contributing to the achievement of Sustainable Development Goals (Goal 8, decent work and economic growth; Goal 9, industry, innovation, and infrastructure; Goal 12, responsible consumption and production; Goal 13, climate action; Goal 17, partnership for the goals) through improved resource management and sustainable practices.