This paper aims to explain why Chinese small and medium enterprises (SMEs) in the mobile handset industry pursue innovation without novelty, and how they can survive and thrive within a system which appears to be arrayed against them. We argue that China’s practice of imitation-innovation-fusion in the mobile handset industry was chosen as it was the most rational means of seeking economic returns under China’s climate of structured uncertainty and the global fragmentation of production. This innovation strategy can also be explained by a silent alliance between firms and localities, a special type of local protectionism mediating uncertainties from national and international competition. Policy implications are discussed in the end.