The tags, which are extremely small, could one day replace bar codes on product packaging, using special microchips to communicate wirelessly with computers when scanned. The scanning can be automated to track goods as they flow through the supply chain--from manufacturers to distributors to stores and eventually to customers. The tags currently cost around 50 cents apiece, and will need to come way down in price before their use becomes practical on individual products, analysts say.

But retailers are still pushing for them. Retailing giant Wal-Mart is expected this week to ask its top 100 suppliers to begin using the chips to help track inventory by 2005.

Privacy advocates have raised warning flags about the technology, especially its inclusion in garments. The inventory-tracking chips are expected to include a kill switch before they end up in products.

Auto ID will be developing standards for the Electronic Product Code Network, which uses radio frequency and network systems to identify products. Microsoft said its work will initially focus on supply chains in the manufacturing and retail sectors. Further ahead, the company said it will work with partners to develop RFID technology throughout the supply chain.

Ed Rerisi, director of research at Allied Business Intelligence (ABI), said the RFID market is more than just tags and readers and that there's a huge opportunity for software and service companies to participate in the market.

"Microsoft is trying to address a vacuum in the back-end integration of RFID inventory systems," Rerisi said.

ABI estimates that revenue from tags, readers and software and services could add up to as much as $3 billion by 2008.

News.com's Richard Shim contributed to this report.