XP Mode is an acknowledgement that many customers skipped Vista and will move to Windows 7 directly from the eight year old XP OS. Microsoft says XP Mode supports older or custom-built applications, maintaining backward compatibility through a virtual Windows XP SP3 environment running under the Windows Virtual PC.
Customers that buy Windows 7 Professional, Enterprise and Ultimate editions will get XP Mode as a free download however it is important to note that there are some hardware considerations. A minimum of 2GB’s of RAM, 15GB of hard disk space and as well (very important) a virtualization enabled processor from Intel or AMD.
Read the article by Ed Bott of ZDNET: How many Intel CPUs will fail the XP Mode test in Windows 7?