Under the context of a global economic downturn, China is proactively seeking structural reform and transformation to maintain and promote sustainable economic growth. Recognising innovation as increasingly critical, China now endeavours to transform from a low value-added manufacturer to a global-leading designer and innovator. Through a large number of tailored initiatives and programmes, significant efforts have been made by both central and local governments to facilitate nation-wide innovative development. Representing the majority of Chinese firms and the main foundation of the manufacturing base, Small and Medium-sized Enterprises (SMEs), which were historically considered as low-tech and resource-intensive manufacturers, have been the target of these supportive policy schemes and are becoming an emerging force for innovation. The rise of innovative SMEs in Chinese manufacturing sectors is fundamentally changing market structures and relationships, leading to the transition of Chinaâs innovation system. This thesis studies innovation strategies and networks among SMEs in Chinese manufacturing sectors, explores the knowledge creation and diffusion process in the fundamental Chinese market, and sheds light on the transitional process of Chinaâs innovation system towards an indigenous and advanced one. Using the multiple case study method, the research presents three key findings: 1) it identifies five types of innovation strategies, labeled as Exist, Enhance, Integrate, Edge and Switch strategies, with different selections and combinations between exploitation and exploration; 2) it analyses and demonstrates relationships between the five innovation strategies and different external resources (including vertical and horizontal networks) in-depth; and 3) it explores the process of knowledge creation and knowledge diffusion in Chinaâs innovation system and illustrates the emergence of innovative transition in China from the perspective of SMEs. This research contributes to innovation theory by identifying different possibilities between exploitation and exploration in SMEs, and linking innovation strategies and networking strategies. It also enriches the innovation system and catching-up literature by providing a bottom-up perspective from the lens of SMEs in a transitional economy. Practically, this research provides an in-depth understanding of the innovation development in the Chinese market and describes the development trajectories of Chinaâs innovation system, and also discusses some political and managerial implications.