Philips' semiconductor unit will make tiny radio chips that can be stuck on items from clothes to bottles of milk, while IBM will provide the computer services and systems.
No financial details were disclosed.
By using so-called radio frequency identification (RFID) chips, manufacturing companies and retailers will be able to track closely their inventories.
RFID chips, which in a few years time are likely to cost a few cents or even less, are thin and small and send essential bits of information about a product to a receiver that can read the signals. The data could include a product description, packaging and expiry dates, color and price. It is a more advanced way to track and describe goods than barcodes, which are now used for most products and inventory systems.
The market opportunity of RFID tags is estimated at $3.1 billion by 2008, according to research group Applied Business Intelligence. Another research group, IDC, estimates that retail demand alone will be $1.3 billion within four years.
Philips said it would be its own customer when later this year it tags wafer cases and carton packages at its semiconductors Kao Hsiung manufacturing site in Taiwan and the division's distribution center in Hong Kong.
Research groups estimate that some $40 billion of excess inventory of consumer goods and retail items are in the supply chain at any given time. The tags could help reduce theft and inventory levels by 25 percent, they said.