Microsoft's Home and Entertainment division is stepping up efforts to comply with radio-frequency identification technology requirements set down by Wal-Mart Stores Inc. and other retailers.

Shortly after the New Year rings in, RFID-tagged cases and pallets containing Xboxes, computer games, software, keyboards, and mice will leave Microsoft's Memphis distribution center and travel to Wal-Mart's Texas distribution centers. Some products will be sent directly to 132 of the retailer's stores across the country. Microsoft's Home and Entertainment division is one of the 137 suppliers taking part in Wal-Mart's first wave of RFID suppliers asked to begin using RFID by Jan. 1.

It's been a yearlong process to understand RFID's benefits and potential obstacles, and Microsoft has made this project a top priority since March. It put together a team and began making many trips to Wal-Mart's headquarters in Bentonville, Ark., to understand the retailer's requirements. Microsoft signed up consulting firm Accenture in June to help map out the strategy. "Today we have the guts of the systems and the processes in place, and we're beginning to test read rates and pass product through some of the RFID infrastructure," says Mike Quinn, general manager for North America operations at the Home and Entertainment division. "We're ready for the January rollout with Wal-Mart."

The hope is that RFID can more quickly and efficiently move shipments, which average between 30 million and 40 million units annually, out the door and into retail stores. Microsoft's Memphis, Tenn., distribution center is fully automated with miles of conveyers. Handheld readers are used to scan products, verify orders, and print labels for shipments. Microsoft has begun working to incorporate new procedures to embed RFID tags in its labels, but it wants to be sure the technology doesn't disrupt or add steps to its pick, pack, and ship process.

In Microsoft's current implementation, the data from RFID chips is picked up by readers and sent to standalone test environment built on software systems that Quinn declined to identify. Accenture is helping to integrate the platform. The data is then fed into a networked PC so the Home and Entertainment division can check real-time inventory levels and shipping information. When goods arrive, Wal-Mart can transmit back a signal to Microsoft verifying receipt.

During the testing phase, the data will remain isolated, but accessible, to Microsoft's SAP ERP system. For now, Microsoft employees will manually affix labels to containers, and the company will continue to improve the accuracy of read rates. In the last three months, since the RFID equipment was set up, pallets stacked with 84 cases of Xbox software have been successfully read better than 90% of the time. "We went in thinking we'd have a much harder time in some of read-rate tests deep inside a pallet, and it hasn't been the case," Quinn says.

There also is the possibility that Microsoft could bring its distributor Technicolor, a Thomson Digital Content Solutions business unit, and Flextronics International Ltd., which manufactures the Xbox in China, into the RFID mix. Long term, Quinn says he wants to use the data on RFID chips tied to partners' back-end databases that Microsoft could access. That way, Microsoft could keep better tabs on returns, warranties, and repairs. "For information about the product to travel from China, or wherever it's manufactured, through point of sale is powerful," Quinn says. RFID could also help eliminate the spread of counterfeit products, he says.

The options are limitless, Quinn says. But the challenge is to keep expenses in check. The Home and Entertainment division, which Microsoft categorizes as "emerging," operated in the red last quarter, end Sept. 30. RFID project costs are being closely eyed to prevent an increase in per-unit prices, which are typically measured by "cost of goods sold." Even at the case and the pallet level, RFID could have a measurable impact to manufacturing costs if expenses aren't watched closely.

Still, Microsoft takes the view that deploying RFID is an opportunity to improve visibility throughout its supply chain. Company executives declined to provide specifics, but did say Microsoft will recoup expenses and drive value by taking the implementation beyond what's referred to as slap-and-ship compliance, where RFID tags are affixed just before goods are sent to customers. "We don't ship as many cartons and cases as Proctor & Gamble, but even for us it's a significant cost," says Drew Gude, program manager for manufacturing solutions and industry solutions architecture, Microsoft Business Solutions. "So we have to look at the investment just like any other retailer."

Luckily, Microsoft has more to gain from its RFID initiative than meeting Wal-Mart's mandate and improving its supply chain. It can also use the experience to benefit its ERP software. Microsoft Business Solutions earlier this year began working to build RFID capabilities into its Navision and Axapta applications.