Innovation in smes exhibits some peculiar features that most traditional indicators of innovation activity do not capture. Therefore, in this paper, we develop a structural model of innovation that incorporates information on innovation success from firm surveys along with the usual r&d expenditures and productivity measures. We then apply the model to data on italian smes from the “survey on manufacturing firms” conducted by mediocredito-capitalia covering the period 1995–2003. The model is estimated in steps, following the logic of firms’ decisions and outcomes. We find that international competition fosters r&d intensity, especially for high-tech firms. Firm size and r&d intensity, along with investment in equipment, enhances the likelihood of having both process and product innovation. Both these kinds of innovation have a positive impact on firm’s productivity, especially process innovation. Among smes, larger and older firms seem to be less productive.