Once upon a time, a company called Connectix developed a product named Virtual PC. Microsoft acquired the Virtual PC technology back in 2003. That original product went through a couple of enhancements, and Virtual PC 2007 was eventually released as a free download for all Windows users.
Windows XP Mode is simply Windows XP (with Service Pack 3) running in the most recent version of Virtual PC, now dubbed Windows Virtual PC and tuned to run on Windows 7. Windows XP mode is a full installation of Windows XP Professional (again, with Service Pack 3), including a pre-configured virtual hard drive. It takes the guesswork out of configuring a virtual machine, although you can always reconfigure some of the settings by running Windows Virtual PC.
Windows XP mode is narrowly focused at enabling legacy, 32-bit Windows XP apps to run on Windows 7. More importantly, it’s aimed at business applications. Bad news for gamers: one of the key features left out of Windows XP mode is virtualized access to the physical graphics cards. In other words, there’s no hardware-accelerated 3D in Windows XP mode, so no 3D games will run unless they’re much older games that shipped with a software 3D renderer.
Of course, that doesn’t mean that you can’t run any games. Titles that were exclusively 2D work fine, as we can see with Age of Wonders II.