diff --git a/plugin/package.json b/plugin/package.json
new file mode 100644
index 00000000..519346e8
--- /dev/null
+++ b/plugin/package.json
@@ -0,0 +1,13 @@
+{
+  "name": "claude-mem-plugin",
+  "version": "7.0.3",
+  "private": true,
+  "description": "Runtime dependencies for claude-mem bundled hooks",
+  "type": "module",
+  "dependencies": {
+    "better-sqlite3": "^12.5.0"
+  },
+  "engines": {
+    "node": ">=18.0.0"
+  }
+}
diff --git a/plugin/scripts/smart-install.js b/plugin/scripts/smart-install.js
index ee79f332..87872141 100644
--- a/plugin/scripts/smart-install.js
+++ b/plugin/scripts/smart-install.js
@@ -4,6 +4,8 @@
  * Smart Install Script for claude-mem
  *
  * Features:
+ * - Detects execution context (cache vs marketplace directory)
+ * - Installs dependencies where the hooks actually run (cache directory)
  * - Only runs npm install when necessary (version change or missing deps)
  * - Caches installation state with version marker
  * - Provides helpful Windows-specific error messages
@@ -12,20 +14,30 @@
  */
 
 import { existsSync, readFileSync, writeFileSync } from 'fs';
-import { execSync, spawnSync, spawn } from 'child_process';
-import { join } from 'path';
+import { execSync } from 'child_process';
+import { join, dirname } from 'path';
 import { homedir } from 'os';
 import { createRequire } from 'module';
+import { fileURLToPath } from 'url';
 
-// CRITICAL: Always use marketplace directory for ALL operations
-// This script may run from the cache directory (plugin/scripts/) but must
-// operate on the marketplace directory where package.json and node_modules live.
-// This ensures cross-platform compatibility and avoids cache directory confusion.
-const MARKETPLACE_ROOT = join(homedir(), '.claude', 'plugins', 'marketplaces', 'thedotmack');
+// Determine the directory where THIS script is running from
+// This could be either:
+// 1. Cache: ~/.claude/plugins/cache/thedotmack/claude-mem/X.X.X/scripts/
+// 2. Marketplace: ~/.claude/plugins/marketplaces/thedotmack/plugin/scripts/
+const __dirname = dirname(fileURLToPath(import.meta.url));
+const SCRIPT_ROOT = dirname(__dirname); // Parent of scripts/ directory
+
+// Detect if running from cache directory (has version number in path)
+const CACHE_PATTERN = /[/\\]cache[/\\]thedotmack[/\\]claude-mem[/\\]\d+\.\d+\.\d+/;
+const IS_RUNNING_FROM_CACHE = CACHE_PATTERN.test(__dirname);
+
+// Set PLUGIN_ROOT based on where we're running
+// If from cache, install dependencies IN the cache directory (where hooks run)
+// If from marketplace, use marketplace directory
+const PLUGIN_ROOT = IS_RUNNING_FROM_CACHE
+  ? SCRIPT_ROOT  // Cache directory (e.g., ~/.claude/plugins/cache/thedotmack/claude-mem/7.0.3/)
+  : join(homedir(), '.claude', 'plugins', 'marketplaces', 'thedotmack');
 
-// Use MARKETPLACE_ROOT for all paths - this script can be deployed anywhere
-// but always operates on the marketplace directory
-const PLUGIN_ROOT = MARKETPLACE_ROOT;
 const PACKAGE_JSON_PATH = join(PLUGIN_ROOT, 'package.json');
 const VERSION_MARKER_PATH = join(PLUGIN_ROOT, '.install-version');
 const NODE_MODULES_PATH = join(PLUGIN_ROOT, 'node_modules');
@@ -102,6 +114,12 @@ function setInstalledVersion(packageVersion, nodeVersion) {
 }
 
 function needsInstall() {
+  // Check if package.json exists (required for npm install)
+  if (!existsSync(PACKAGE_JSON_PATH)) {
+    log(`⚠️  No package.json found at ${PLUGIN_ROOT}`, colors.yellow);
+    return false; // Can't install without package.json
+  }
+
   // Check if node_modules exists
   if (!existsSync(NODE_MODULES_PATH)) {
     log('📦 Dependencies not found - first time setup', colors.cyan);
@@ -155,9 +173,8 @@ async function verifyNativeModules() {
   try {
     log('🔍 Verifying native modules...', colors.dim);
 
-    // CRITICAL: Use createRequire() to resolve from MARKETPLACE_ROOT
-    // This script may run from cache but must load modules from marketplace's node_modules
-    const require = createRequire(join(MARKETPLACE_ROOT, 'package.json'));
+    // Use createRequire() to resolve from PLUGIN_ROOT's node_modules
+    const require = createRequire(join(PLUGIN_ROOT, 'package.json'));
     const Database = require('better-sqlite3');
 
     // Try to create a test in-memory database
@@ -247,7 +264,8 @@ async function runNpmInstall() {
   const isWindows = process.platform === 'win32';
 
   log('', colors.cyan);
-  log('🔨 Installing dependencies...', colors.bright);
+  log(`🔨 Installing dependencies in ${IS_RUNNING_FROM_CACHE ? 'cache' : 'marketplace'}...`, colors.bright);
+  log(`   ${PLUGIN_ROOT}`, colors.dim);
   log('', colors.reset);
 
   // Try normal install first, then retry with force if it fails
@@ -274,7 +292,7 @@ async function runNpmInstall() {
         throw new Error('better-sqlite3 installation verification failed');
       }
 
-      // NEW: Verify native modules actually work
+      // Verify native modules actually work
       const nativeModulesWork = await verifyNativeModules();
       if (!nativeModulesWork) {
         throw new Error('Native modules failed to load after install');
@@ -331,16 +349,15 @@ async function runNpmInstall() {
   return false;
 }
 
-/**
- * Check if we should fail when worker startup fails
- * Returns true if worker failed AND dependencies are missing
- */
-function shouldFailOnWorkerStartup(workerStarted) {
-  return !workerStarted && !existsSync(NODE_MODULES_PATH);
-}
-
 async function main() {
   try {
+    // Log execution context for debugging
+    if (IS_RUNNING_FROM_CACHE) {
+      log('📍 Running from cache directory', colors.dim);
+    } else {
+      log('📍 Running from marketplace directory', colors.dim);
+    }
+
     // Check if we need to install dependencies
     const installNeeded = needsInstall();
 
@@ -355,7 +372,7 @@ async function main() {
         process.exit(1);
       }
     } else {
-      // NEW: Even if install not needed, verify native modules work
+      // Even if install not needed, verify native modules work
       const nativeModulesWork = await verifyNativeModules();
 
       if (!nativeModulesWork) {
@@ -371,10 +388,10 @@ async function main() {
       }
     }
 
-      // NOTE: Worker auto-start disabled in smart-install.js
-      // The context-hook.js calls ensureWorkerRunning() which handles worker startup
-      // This avoids potential process management conflicts during plugin initialization
-      log('✅ Installation complete', colors.green);
+    // NOTE: Worker auto-start disabled in smart-install.js
+    // The context-hook.js calls ensureWorkerRunning() which handles worker startup
+    // This avoids potential process management conflicts during plugin initialization
+    log('✅ Installation complete', colors.green);
 
     // Success - dependencies installed (if needed)
     process.exit(0);
diff --git a/scripts/build-hooks.js b/scripts/build-hooks.js
index 5b49fc26..224f64a0 100644
--- a/scripts/build-hooks.js
+++ b/scripts/build-hooks.js
@@ -58,6 +58,26 @@ async function buildHooks() {
     }
     console.log('✓ Output directories ready');
 
+    // Generate plugin/package.json for cache directory dependency installation
+    // The bundled hooks use `external: ['better-sqlite3']` so dependencies must be
+    // installed at runtime. This package.json enables npm install in the cache directory.
+    console.log('\n📦 Generating plugin package.json...');
+    const pluginPackageJson = {
+      name: 'claude-mem-plugin',
+      version: version,
+      private: true,
+      description: 'Runtime dependencies for claude-mem bundled hooks',
+      type: 'module',
+      dependencies: {
+        'better-sqlite3': packageJson.dependencies['better-sqlite3']
+      },
+      engines: {
+        node: '>=18.0.0'
+      }
+    };
+    fs.writeFileSync('plugin/package.json', JSON.stringify(pluginPackageJson, null, 2) + '\n');
+    console.log('✓ plugin/package.json generated');
+
     // Build React viewer
     console.log('\n📋 Building React viewer...');
     const { spawn } = await import('child_process');