Purpose This paper makes an attempt to demonstrate the importance of breaking absorptive capacity (AC) into two sequential components, to effectively measure and utilize the construct. Design/methodology/approach Data on potential AC, realized AC and firm performance were collected utilizing survey questionnaire administered to 284 Indian SMEs operating in the automotive service segment. Findings To test the proposed hypotheses, the authors broke AC into its two sequential components – potential AC and realized AC, and tested their linkages with firm performance. The authors not only found the sequential components to be more reliable, but also found better explanation of firm performance. Research limitations/implications The findings in this paper have crucial implications for researchers working in the domain of AC and knowledge management. By demonstrating the operationalization of AC as two sequential components, the authors make a case for more effective utilization of the construct in future studies. Originality/value This study is among the few research attempts that have tried to create a sequential operationalization of AC. The findings clearly reveal that potential AC is an enabler of the realized AC, which in turn enhances firm performance.