ARS Technica has taken an in-depth look at Windows 7's XP Mode, you can check out the 5-page coverage over here.
With Windows 7, however, Redmond has provided a solution to the problem: Windows XP Mode. Windows XP Mode uses virtualization technology to let applications running on a virtualized copy of Windows XP show up in the Windows 7 Start menu and on the Windows 7 desktop.
Windows XP Mode is a downloadable add-on for Windows 7 Professional, Ultimate, and Enterprise. It has two parts: the virtualization software itself, and a disk image containing a pre-installed, activated, licensed copy of Windows XP Professional with Service Pack 3 preinstalled, complete with the glorious Internet Explorer 6.