This paper explores the relationship between innovation performance (in terms of product and process) and business performance (sales growth, market share and profitability) and compares this relationship between manufacturing and service firms. This study was driven by the lack of studies on innovation in service sectors despite the importance of innovation as one of the primary sources of competitive advantage. Furthermore, as manufacturing firms and service firms are different in many respects, including innovation performance, it could be expected that manufacturing firms could pursue and emphasise different aspects of innovation than their service counterparts. Empirical data was gathered from 194 managers in Australian firms, with nearly equal proportion drawn from the manufacturing and service sectors (52% and 47% respectively). Several major findings were found through data analysis. First, there was no significant difference between manufacturing and service firms in both product and process innovation performance. The second finding, however, indicated a stronger correlation existed for manufacturing firms than for service firms between innovation and business performance, particularly in relation to process innovation. Third, it was found that process innovation shows a relatively stronger relationship with business performance than product innovation in manufacturing sectors. Copyright © 2006 John Wiley & Sons, Ltd.