They heard from analyst Michael Pachter that Microsoft will likely have made an agreement with NVIDIA to emulate the part of NVIDIA's chipset that is needed for certain Xbox games, in exchange for a small royalty fee. This means NVIDIA will still get paid for every Xbox 360 console, even though they don't deliver the GPUs anymore.
Apparently, for Xbox games that are written in a single layer (which MS management believes to be most of the Xbox library) the emulation should be pretty smooth. The smaller percentage of Xbox titles that are written in multiple layers will require "patches" (separate emulation programs) in order to work. Pachter says that Microsoft currently plans to sell the 360 with these patches already pre-loaded on the included 20GB hard drive. It is also conceivable that any additional patches for other Xbox games could be easily downloaded over Xbox Live.