The purpose of this study is to elucidate the role of digital innovation in mediating digital capabilities on business performance. The sampling method used is purposive sampling. The number of samples is 75 respondents. Data collection is carried out by distributing questionnaire to SME managers in IT sector in Denpasar City. The data analysis technique used is the Path Analysis and Sobel Test technique. The results of the study show that the digital capability variable has a positive and significant effect on business performance. Likewise, digital innovation has a positive and significant effect on business performance, and digital innovation is able to mediate the effect of digital capabilities on business performance. Therefore, in the future, SMEs in IT sector must always improve their digital capabilities in order to develop digital innovations that have an impact on improving business performance.