This paper is one of the first to discuss obstacles of innovation in Palestine. We have empirically addressed the main obstacles or hampers of innovation and their influences on innovation capabilities in the knowledge intensive business service using a cross sectional data for a sample of 263 firms provided through a quantitative survey approach. Binary choice logit model has been employed to estimate the relationship between obstacles of innovation and the ability of firms to innovate. The model is run separately for every dependent variable (product, process, organizational and marketing). Each of the dependent variables has two possibilities; to innovate or not. The results show that the innovation obstacles are hampering the propensity of firms to innovate in different levels. Considering the different types of innovation that were assessed in this study, the cost factor (including lack of funds and lack of finance from outside the firm and the high innovation cost) is the factor with the greatest negative impact on the product and process of innovation as well as the organizational and marketing innovation, followed by the demand factor which was reflected by the weak competition and uncertainty and the impact of the prior innovation. On the other hand the knowledge factor had a positive impact on a number of firms that focus on organizational and marketing innovation which were able to overcome it and address it.