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Windows XP Mode is a feature in Windows 7 Enterprise, Professional and Ultimate Editions. It is an actual full-license copy of Windows XP which can be run as a virtual machine on the Windows 7 PC via the Windows Virtual PC Type 2 Client Hypervisor. It can be used to run software and hardware peripherals which are no longer compatible with Windows 7, essentially acting as a compatibility tool.
Windows XP Mode is a feature in some versions of Windows 7 which allows the user to use legacy hardware peripherals and software through a virtual machine which runs a full-version copy of Windows XP. The Windows XP license itself is already included with the compatible Windows 7 license and is not required during installation on the virtual machine since this is automatically detected.
The earliest versions of Windows XP Mode required special virtualization-enabled hardware which made it largely ineffective since its main purpose was to support legacy hardware, which often did not have virtualization-enabled hardware. However, newer versions only require hardware powerful enough to run multiple virtual machines, so even on older but powerful hardware the features can be made fully compatible.
Windows XP Mode was made as a stop-gap measure in order to ease the migration from Windows XP to Windows 7 since features and programs that run only on XP can still be used even when already on Windows 7 without the need to write costly patches for enterprise software quickly, allowing for proper migration measures to be implemented.